]]>A recent chapter 15 decision by Judge Martin Glenn of the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) suggests that third-party releases susceptible to challenge or rejection in chapter 11 proceedings may be recognized and enforced under chapter 15. This decision provides companies with cross-border connections a path to achieve approval of non-consensual third-party guarantor releases in the U.S.

Background

The company, Avanti Communications Group (“Avanti”), was a Ka-band satellite operator, providing wholesale satellite data communications services throughout Europe, the Middle East and Africa. (In case you didn’t already know, the Ka band [pronounced as either “kay-ay band” or “ka band”] is a portion of the microwave part of the electromagnetic spectrum. The 30/20 GHz band is used in communications satellite uplinks and high-resolution, close-range targeting radars aboard military airplanes. Some frequencies in this radio band are used for vehicle speed detection by law enforcement, or at least that’s what Wikipedia tells us.) Headquartered in London, Avanti was incorporated under the laws of England and Wales as a public limited company.

Prior to its restructuring, Avanti had approximately $1 billion in funded debt obligations, comprised of approximately $118 million in outstanding super-senior term loans maturing in 2020 (the “Term Loans”), $323 million in outstanding senior secured notes maturing in 2021 (the “2021 Notes”), and $557 million in outstanding senior secured notes maturing in 2023 (the “2023 Notes,” together with the 2021 Notes, the “Notes”). The issued debt was guaranteed by Avanti and each of its direct and indirect subsidiaries.

In late 2017, Avanti faced increasing financial pressures due to an overleveraged capital structure and delays in manufacturing and procurement. Avanti and an ad hoc group of holders of its Terms Loans and Notes entered into preliminary discussions for a comprehensive balance sheet restructuring.

Subsequently, Avanti entered into a restructuring support agreement (“RSA”) with creditors comprising 62% of its outstanding 2021 Notes, and 55% of its outstanding 2023 Notes. The RSA set out the terms of a debt-for-equity swap of Avanti’s 2023 Notes and the amendment of its 2021 Notes, which was to be implemented pursuant to a scheme of arrangement under the UK Companies Act 2006 (the “Scheme”). In order to effectuate the Scheme, it had to first be sanctioned by the High Court of Justice of England and Wales (the “English Court”).

The Sanctioning of the Avanti Scheme

Avanti initiated a proceeding before the English Court for approval of the Scheme. The English Court considered the application and issued a Convening Order, requiring the meeting of the impaired creditors (i.e., holders of the 2023 Notes). Because the impaired creditors were comprised exclusively of holders of the 2023 Notes, the Scheme consisted of one voting class.

The Avanti Scheme granted third-party releases, including releases of guarantors of the 2023 Notes (the “Guarantor Releases”). The proposed Guarantor Releases prohibited creditors from seeking recovery against Avanti or its subsidiary guarantors.

At the meeting, the impaired creditors, holding 98.3% of the outstanding 2023 Notes, attended and voted in favor of the Scheme. None of the impaired creditors voted against the Scheme. As a result, the English Court sanctioned the Scheme, finding jurisdictional, statutory and fairness requirements to be satisfied. To protect its reorganization efforts and ensure fair and efficient administration of the restructuring, Avanti sought to then have the Scheme recognized in the U.S. under chapter 15 of the Bankruptcy Code.

U.S. Chapter 15 Proceeding

A U.S. chapter 15 case, unlike chapter 11, is ancillary to a primary proceeding in a foreign jurisdiction. The chapter 15 case is recognized by the Bankruptcy Court, rather than independently commenced. In seeking assistance from U.S. courts, chapter 15 requires that the foreign proceeding be brought by a foreign representative. The Bankruptcy Court must first recognize the foreign proceeding.

For a U.S. chapter 11 restructuring to commence, a debtor must meet the eligibility requirements of § 109(a) of the Bankruptcy Code. In In re Barnet, the Second Circuit affirmed that the eligibility requirements for debtors under § 109(a) of the Bankruptcy Code apply equally in chapter 15 restructurings. A debtor must show that it has either (i) domicile, (ii) a place of business, or (iii) property in the U.S. as a condition of eligibility. Notably, immediately following the decision in In re Barnett, the Delaware Bankruptcy Court, in In re Bemarmara Consulting, took a different view, holding that the requirements of § 109(a) did not apply to debtors seeking recognition under chapter 15.

Avanti had neither domicile nor a place of business in the U.S. The Bankruptcy Court did, however, deem a $100,000 retainer deposited for Avanti’s counsel in a U.S. bank sufficient to meet the Bankruptcy Code’s eligibility requirements. Having met the procedural requirements of chapter 15, as determined by the Second Circuit, Avanti asked the Bankruptcy Court to recognize and enforce the Scheme.

Upon achieving recognition of foreign main proceedings, § 1521(a) of the Bankruptcy Code authorizes the court to grant any appropriate relief, effectuating the objective of chapter 15. Relief in this instance may be narrowly limited by the public policy exception. For example, whether the third-party releases so greatly offend principles of U.S. public policy.

Avanti Gets its Releases Approved

While acknowledging the inconsistent approval of third-party releases by U.S. bankruptcy courts, Judge Glenn ultimately decided he could, nonetheless, grant recognition and enforcement of a foreign order authorizing such third-party releases. Importantly, it was not necessary for the guarantors to commence a case (either in the U.K. or in the U.S.) to obtain the benefit of the third-party releases; the Guarantor Releases provided in the Scheme were sufficient.

Avanti’s facts were unique, distinguishing it from other cases where third-party releases were denied, including in the chapter 15 context. Although principles of comity were integral to Judge Glenn’s decision, the specific facts of the Avanti favored third-party releases.

First, no objections were filed in the Bankruptcy Court against the Scheme and it had near-unanimous support from voting-impaired creditors.

Second, the U.K. procedure proceeded in accordance with U.S. due process concepts, strengthening the argument for recognition.

Lastly, unlike chapter 11, the U.K. Companies Act 2006 authorizing schemes does not provide a mechanism for “cramming down” dissenting classes of creditors. All that is required is that 75% of the voting shares of the creditor class vote in favor of the scheme. This threshold was overwhelmingly surpassed in Avanti. Further, third-party releases are not categorically prohibited and, therefore, are not contrary to public policy in the U.S. Under § 1521 of the Bankruptcy Code, the Bankruptcy Court has discretion to provide any appropriate relief, where necessary to effectuate the purpose of chapter 15.

The Bankruptcy Court determined that the Scheme was capable of recognition in the U.S. so long as it did not prejudice the rights of U.S. citizens or violate U.S. domestic public policy. Additionally, he deemed the Guarantor Releases as being necessary to give practical effect to the Scheme. He expressed concern that failure to enforce the Guarantor Releases would otherwise have significantly prejudiced creditors to the detriment of the reorganization.

Judge Glenn took care to distinguish the case on its facts before recognizing the Scheme, thereby, enforcing the Guarantor Releases in the U.S. Further, not all companies will be able to avail themselves of the Scheme process in the U.K. (or other analogous jurisdictions). It is unlikely that this decision harbingers a sea change in complex corporate restructuring, but the outcome in Avanti does present companies with an additional avenue to address their restructuring requirements, should the circumstances allow.

]]>Comity for Croatia: S.D.N.Y. Decision in Agrokor Reinforces Respect for Foreign Rulings in Chapter 15https://business-finance-restructuring.weil.com/chapter-15/comity-for-croatia-sdny-decision-agrokor-reinforces-respect-for-foreign-rulings-chapter-15/
Tue, 20 Nov 2018 16:40:03 +0000http://business-finance-restructuring.weil.com/?p=16037In Judge Glenn’s recent lengthy decision recognizing and enforcing a restructuring plan in the chapter 15 proceedings of In re Agrokor1, a Croatian company in Croatian insolvency proceedings, he highlighted that the concept of comity – respect for rulings in other countries – remains an important U.S. judicial policy in […]

]]>In Judge Glenn’s recent lengthy decision recognizing and enforcing a restructuring plan in the chapter 15 proceedings of In re Agrokor1, a Croatian company in Croatian insolvency proceedings, he highlighted that the concept of comity – respect for rulings in other countries – remains an important U.S. judicial policy in insolvency proceedings, seemingly more important here than in certain other countries. ProTip: This decision provides a good overview of chapter 15 and a deep discussion of comity principles for anyone who wants to learn more about these interesting topics.

Background

When Agrokor, the largest private company in Croatia by revenue, experienced financial distress, the Croatian government passed a special insolvency law for “systemically important companies” (defined with reference to the size of debt and number of employees). Among other provisions, the law provided for the appointment of an administrator (the Extraordinary Commissioner) selected by the Croatian government, but in many other respects, the law incorporated concepts similar to those in U.S. chapter 11 proceedings, such as notice to creditors and achieving certain creditor voting thresholds before the restructuring plan could become effective.

Judge Glenn had previously recognized the Croatian insolvency proceeding as a foreign main proceeding (a typical step in chapter 15 proceedings) and now faced a request by the foreign representative2 to recognize the restructuring plan itself. A decision by Judge Glenn to recognize the restructuring plan would make it binding and enforceable in the United States.

Potential Obstacles to Recognition

Although there were no objections to the relief requested by the foreign representative, the court noted several potential obstacles to granting the requested relief.

The first interesting obstacle faced by Agrokor was that courts in several countries had already refused to grant recognition to Agrokor’s Croatian insolvency proceedings, including Bosnia-Herzegovina, Serbia, Slovenia and Montenegro. These courts seemed bothered by what they perceived as a law that was enacted to benefit the government of Croatia, rather than benefit creditors. It should be noted that the proceeding was recognized in England and Wales, Switzerland, and (seemingly) the European Union (despite Slovenia’s denial of recognition).

The second interesting obstacle was the “Gibbs Rule” in England and Wales, which was originally adopted in the late 1800s, but continues to be applied by courts in England and Wales in 2018. The Gibbs Rule provides that the courts in England and Wales will not enforce a foreign insolvency proceeding as it applies to English- law governed debt documents. Interestingly, in this case, the court in England and Wales had granted recognition to the Croatian insolvency proceedings themselves, but had not yet decided whether to grant recognition to the restructuring plan, including as it applied to Agrokor’s English-law governed debt.

Overcoming the Obstacles

Agrokor is not the first case in which a U.S. bankruptcy court has had to determine whether to recognize a restructuring plan derived from bespoke laws enacted in a foreign jurisdiction as a result of a local crisis. The United States Bankruptcy Court for the District of Delaware has also been faced with similar circumstances in the chapter 15 case of the Irish Bank Resolution Corporation, the entity created to liquidate certain distressed Irish banks pursuant to the Irish Bank Resolution Corporation Act 2013.

Ultimately, and like its sister court in Delaware, the U.S. Bankruptcy Court for the Southern District of New York was not swayed by the aforementioned foreign decisions and rules, and was instead guided by longstanding precedent in the United States in favor of comity. The court noted that the insolvency proceeding was generally procedurally fair and shared many of the same creditor protections available in the United States, including creditor rights to meaningful participation and an ability to vote on a restructuring plan. The fact that the Croatian process differed somewhat from what would be permitted in a U.S. chapter 11 case did not mean the restructuring plan was not to be granted comity, as recognition would not be “manifestly contrary to U.S. public policy” (a standard in section 1506 of the Bankruptcy Code). Similarly, the fact that other courts might not recognize the restructuring plan, including due to the Gibbs rule, was not a reason to deny chapter 15 recognition and enforcement in the United States.

Agrokor demonstrates that despite what one may think based on recent events in other spheres, respect for rulings in other countries remains live and well in bankruptcy courts in the United States.

]]>Return to Sender? Domestic Reach of Foreign Stay Can Be Modified in Chapter 15 Recognition Order, Without Trip to Foreign Courthttps://business-finance-restructuring.weil.com/chapter-15/return-to-sender-domestic-reach-of-foreign-stay-can-be-modified-in-chapter-15-recognition-order-without-trip-to-foreign-court/
Thu, 18 Aug 2016 17:16:27 +0000http://business-finance-restructuring.weil.com/?p=15671Contributed by Brian Wells A recent decision by the United States Bankruptcy Court for the Western District of Texas in In re Sanjel (USA) Inc. is a reminder that in a chapter 15 case, the U.S. bankruptcy court will not always apply the law of the foreign jurisdiction to U.S. […]

A recent decision by the United States Bankruptcy Court for the Western District of Texas in In re Sanjel (USA) Inc. is a reminder that in a chapter 15 case, the U.S. bankruptcy court will not always apply the law of the foreign jurisdiction to U.S. creditors and U.S.-based claims. Specifically, the case adds a wrinkle to caselaw addressing the domestic application of foreign stays through chapter 15, and in particular whether it is appropriate for a bankruptcy court to modify or limit a foreign stay through changes to its recognition order (i.e., the order that gives a foreign stay effect in the United States).

The decision involves Sanjel (USA) Inc. and its related entities (collectively a multi-national energy services provider), which had originally commenced reorganization proceedings in Canada pursuant to the Companies’ Creditor Arrangement Act, or “CCAA.” The Canadian court granted the debtors certain protections, which included a broad stay of any actions against their directors and officers (as is permitted under Canadian law). Soon after, at the debtors’ request, the United States bankruptcy court recognized the CCAA proceedings under chapter 15 of the Bankruptcy Code and entered a recognition order extending the reach of the Canadian stay to the United States.

For readers in need of a refresher on the basic chapter 15 mechanics, a key premise is that, standing alone, foreign insolvency courts have no jurisdiction in the United States (hence, a stay issued by a Canadian court would have no effect in the in the United States). Historically, bankruptcy courts may have honored foreign law under former Bankruptcy Code section 304 and through the nebulous, common law doctrine of “comity”. However, with the enactment and codification of chapter 15 in 2005, the former scheme was replaced with a statutory framework based on the internationally recognized Model Law on Cross Border Insolvency (drafted by the United Nations Commission on International Trade Law). Among other things, chapter 15 provided bankruptcy courts with a means to “recognize” foreign insolvency proceedings and, through section 1521, use its jurisdiction to “grant any appropriate relief.”

As mentioned, the Sanjel bankruptcy court entered a recognition order that, among other things, gave domestic force to the Canadian stay of legal proceedings against the debtors’ directors and officers. Affected claimants included certain of the debtors’ U.S.-based employees who wanted to pursue claims arising under the United States Fair Labor Standards Act, or “FLSA.” (The FLSA creates a statutory cause of action allowing employees to seek damages (and, in some cases, attorneys’ fees) against corporate officers and directors on account of unpaid minimum wages or overtime.) Importantly, the statute of limitations on FLSA claims may continue to run during the pendency of a chapter 15 case, meaning that the continued imposition of the automatic stay could extinguish the employees’ claims. For this reason, two employees sought to modify the Canadian stay granted in the recognition order.

They met vigorous opposition from the debtors, who contended that the recognition order was not prejudicial to the employees because they could seek relief before the Canadian court, and that any modification would be prejudicial to the debtors whose limited personnel would be distracted from their restructuring efforts. The debtors’ arguments appeared solid, as identical points had won the day in In re Nortel Corp. in a dispute involving the same issues (though different claims) before the United States Bankruptcy Court for the District of Delaware, and again on appeal to the district court. The Nortel bankruptcy court had ultimately concluded that, if parties believed they were prejudiced by the stay imposed by the Canadian courts and given effect in the United States by a recognition order, the proper course of action was to seek relief from the Canadian court – not to modify that stay vis-à-vis the recognition order.

The Sangel bankruptcy court, notably, disagreed with the Nortel decision – at least on the facts presented. Section 1522(a) of the Bankruptcy Code permits courts to modify a recognition order so long as “the interests of the creditors and other interested entities, including the debtor, are sufficiently protected.” Following other courts, the bankruptcy court surmised that if the balance of hardships lie with the movant, the recognition order should be modified, but if the balance lay with the debtor (or other interested parties), the order should not. Under the circumstances, the court concluded that the hardships of the employees carried the greatest weight and, accordingly, modified the recognition order (and, thus, the reach of the Canadian stay in the United States) to permit the employees to bring and continue their FLSA claims. The court emphasized that, under the plain language of section 108(c) of the Bankruptcy Code, the statute of limitations for the FLSA claims would continue to run during the proceeding because the automatic tolling provisions only apply to actions against debtors. Without relief from the stay, the movants would not be able to argue this tolling point before the district court that would hear their statutory claims, leaving open the risk of an unfavorable decision after it was too late to take corrective measures. The court also noted that although the debtors’ alleged harms from modification of the recognition order were legitimate, they simply did not counterbalance movants’ risk of entirely losing their statutory claims. Notably, the court declined to follow Nortel for the general rule that litigants should request relief from foreign orders from foreign courts, finding that it would be exceedingly burdensome for the movants to appear in Canadian court to “pursue claims in Colorado based wholly on a statutory right created by United States law to protect employees within the United States.”

Although the facts before the Sanjel bankruptcy court could be cast in a very specific – and unique – light, the implications of this decision remain uncertain. Where debtors restructuring in foreign courts may have once taken comfort by the Nortel bankruptcy and district court decisions (which, if followed as a rule, would have channeled disputes over the U.S. application of foreign stays to the foreign courts that entered them), the varying decisions have created uncertainty on the issue. As such, foreign debtors are now at an increased risk that foreign stays may be subject to change in the United States. For U.S. creditors of foreign companies, however, the Sanjel decision could spare them the hassle of having to travel abroad to seek to protect certain of their rights.

In a chapter 15 decision, In re Daebo International Shipping Co., Judge Michael E. Wiles tackles the issue of the worldwide enforceability of a stay order issued by a foreign court pursuant to the foreign jurisdiction’s bankruptcy statute and offers insight into how a bankruptcy court determines the scope of a foreign court’s order. The question posed to the bankruptcy court was whether maritime attachments made against a shipping vessel docked in Louisiana should be vacated, on the ground that the stay order issued by the Korean court prior to the issuance of such attachments barred attachments on the foreign debtor’s property and other efforts to enforce creditor claims. Ruling in favor of the foreign representative and concluding that the attachments should be vacated, the bankruptcy court analyzed the foreign statute and the declarations submitted by the foreign debtor showing that the stay order was intended to apply to all creditors of the foreign debtor, to all actions such creditors might take, and, by the terms of the stay order itself, to all “rehabilitation creditors,” regardless of location.

Background

Daebo International Shipping Co., Ltd., a debtor organized under the laws of the Republic of Korea, is a shipper of dry bulk cargo and the owner of M/V DAEBO TRADER, a shipping vessel docked in Louisiana. In February 2015, the debtor applied for rehabilitation under the Debtor Rehabilitation and Bankruptcy Act of the Republic of Korea. That statute “permits a court to issue a stay order that prevents any creditor from enforcing a judgment, attaching assets or taking other actions to collect a claim against the entity being rehabilitated.” The Korean court issued the stay order and one month later entered the order formally commencing the debtor’s rehabilitation proceeding. The debtor’s chief executive officer, appointed to take custody of the debtor’s assets and conduct its business, then filed a chapter 15 petition for recognition before the United States Bankruptcy Court for the Southern District of New York, which the court granted.

Over the course of several weeks after the Korean court issued its stay order, certain creditors (referred to as “Rule B Plaintiffs” in the bankruptcy court decision) filed maritime attachment proceedings pursuant to Rule B of the Supplemental Rules for Certain Admiralty and Maritime Claims of the Federal Rules of Civil Procedure in the United States District Court for the Eastern District of Louisiana. Among other things, the Rule B Plaintiffs alleged that the attachments and their claims were actually being asserted against Shinhan Capital Co., the purported lessor of the vessel in a 2007 sale-leaseback transaction between the debtor and Shinhan.

Relying on the sale-leaseback transaction, the Rule B Plaintiffs asserted that the vessel was not an asset of the debtor’s estate and that Shinhan was the real owner of the vessel. After what the court observed was “an unexplained delay,” the debtor moved to vacate the attachments.

Bankruptcy Court’s Holding

In determining the scope of the Korean stay order, the bankruptcy court began its analysis by pointing to section 1521 of the Bankruptcy Court (which sets forth the relief that a bankruptcy court may grant upon recognizing a foreign proceeding). The court observed that it has broad discretion to “grant any appropriate relief that would further the purposes of chapter 15 and protect the debtor’s assets and the interests of creditors.”

The bankruptcy court considered the declarations submitted by the debtor in support of its contention that the stay order is intended to apply to all creditors worldwide, and noted the parties’ pre-hearing stipulation that the Korean court’s stay order “prevented ‘any creditor from taking any enforcement, attachment or other action against the [debtor’s] assets.’” Moreover, the bankruptcy court stated that, at the start of the evidentiary hearing, the Rule B Plaintiffs had agreed the Korean court had “worldwide jurisdiction” over the debtor’s assets.

Holding in favor of the foreign representative, the bankruptcy court parsed through the Korean bankruptcy statute, the declarations submitted by the debtor, and the terms of the stay order itself, observing that their clear intent was to have the stay order “apply to all creditors of Daebo and to all actions they might take.”

Interestingly, the bankruptcy court had occasion to discuss Rule 44.1 of the Federal Rules of Civil Procedure, which is made applicable to bankruptcy cases via Rule 9017 of the Federal Rules of Bankruptcy Procedure. The issue arose because the Rule B Plaintiffs sought to include an additional declaration in a post-trial submission. The debtor objected to its late-inclusion because the evidence had already been closed. In considering the Rule B Plaintiffs’ post-trial submission, the court explained that Rule 44.1 “provides that a determination of foreign law is a question of law (not a question of fact) and that the materials a Court may consider are not limited to materials that would be admissible as evidence.” The court clarified that determining the scope of the Korean stay order was a question of law, and the court would not exclude the post-trial submission by the Rule B Plaintiffs.

Although the Daebo decision is straightforward, it does highlight the necessity of understanding the scope of a foreign court’s order in foreign rehabilitation or bankruptcy proceedings and the rationale behind the bankruptcy court’s expansive view of the scope of the foreign court’s stay order. The decision also touches upon the interplay between the Federal Rules of Civil Procedure and the Bankruptcy Rules, particularly with regard to Rule 44.1, a procedural rule on foreign law with which bankruptcy practitioners may not be intimately familiar.

]]>Chapter 15 for All: SDNY Bankruptcy Court Holds that Indenture Governed by New York Law Constitutes “Property in the United States” Under Section 109(a)https://business-finance-restructuring.weil.com/chapter-15/chapter-15-for-all-sdny-bankruptcy-court-holds-that-indenture-governed-by-new-york-law-constitutes-property-in-the-united-states-under-section-109a/
Fri, 06 Nov 2015 20:29:12 +0000http://business-finance-restructuring.weil.com/?p=14000Contributed by Debra McElligott Section 109(a) of the Bankruptcy Code requires debtors to either reside or have a domicile, place of business, or property in the United States. A split of authority exists whether a foreign debtor seeking recognition of its foreign proceeding under chapter 15 of the Bankruptcy Code […]

Section 109(a) of the Bankruptcy Code requires debtors to either reside or have a domicile, place of business, or property in the United States. A split of authority exists whether a foreign debtor seeking recognition of its foreign proceeding under chapter 15 of the Bankruptcy Code must satisfy these requirements. The United States Bankruptcy Court for the Southern District of New York, where foreign debtors are subject to section 109(a), recently considered how these requirements may be met in In re Berau Capital Resources PTE Ltd. In this case, the court held that an indenture governed by New York law constitutes “property in the United States” for the purposes of section 109(a).

Chapter 15 Eligibility: An Overview

Under section 1515 of the Bankruptcy Code, the foreign representative of a debtor in a foreign proceeding must file a petition for recognition with the bankruptcy court to commence a chapter 15 proceeding. Chapter 15 does not require a foreign debtor to have a connection to the United States; rather, section 1502 defines the term “debtor,” for the purposes of chapter 15, as “an entity that is the subject of a foreign proceeding.” Despite this definition, the United States Court of Appeals for the Second Circuit held in Drawbridge Special Opportunities Fund LP v. Barnet (In re Barnet) that foreign debtors seeking chapter 15 recognition must satisfy one of the requirements of section 109(a) of the Bankruptcy Code. The court based its holding on section 103 of the Bankruptcy Code, which provides that chapter 1 applies in chapter 15.

Just days after the Second Circuit decided Barnet, Judge Kevin Gross of the United States Bankruptcy Court for the District of Delaware held in a bench ruling in In re Bemarmara Consulting a.s. that section 109(a) does not apply to debtors seeking recognition under chapter 15. The court reasoned that in chapter 15, the debtor’s foreign representative – not the debtor – files the petition for recognition, and that section 1502 separately defines “debtor” for the purposes of chapter 15. Judge Gross also noted his belief that the Third Circuit would likely disagree with Barnet as well.

At the outset of its opinion, the Berau court noted that Barnet is a “frequent subject of discussion and criticism,” but that no other federal circuit court has yet addressed whether a foreign debtor must meet the requirements of section 109(a). Applying Barnet, the court then considered whether the foreign debtor had met the requirements of section 109(a).

What Constitutes “Property in the United States”?

The debtor in Berau, a company headquartered in Singapore, did not have a place of business in the United States. The company’s foreign representative relied on a retainer held by its New York counsel to satisfy section 109(a), which the bankruptcy court agreed was “property in the United States.” The court also held, however, that “another substantial (and frequently recurring) basis” for eligibility existed: Berau was an obligor under an indenture governed by New York law.

The court cited several Second Circuit cases for the principle that a debtor’s contract rights are intangible property of the debtor. The court turned to New York law to determine the location of the property, as section 1502(8) of the Bankruptcy Code provides that the location of intangible property rights is to be determined by applicable nonbankruptcy law. Relying on a New York State Court of Appeals opinion by then-Chief Judge Cardozo, the bankruptcy court stated that intangible property rights may have more than one location depending on the purpose for which their location is being determined. One such location, which the court found applicable here, may be the place where an obligation was “meant to be discharged.” The notes under Berau’s indenture were to be discharged in New York.

In addition to its reliance on case law, the court also cited to sections of the New York General Obligations Law that allow parties whose contracts do not have a connection to New York to nonetheless designate New York law as governing law and select the state’s courts as forums for dispute resolution. The court noted that these sections “reflect a legislative policy to permit counterparties to establish a contract site in this state,” and that, even if the contract has a different location for other purposes, these statutory provisions are sufficient to fix the location of rights under that contract in New York. Finally, from a policy standpoint, the court emphasized the irony of allowing a creditor to enforce its rights in New York, but not allowing the company’s foreign representative to obtain chapter 15 protection in the same jurisdiction.

Implications

Debtors that may otherwise have no connection to the United States and would be ineligible for chapter 15 recognition under Barnet are likely to have debt (or other obligations) under contracts subject to New York law or forum selection. The Berau opinion thus alleviates the effect of Barnet and re-opens the doors to the bankruptcy court for foreign debtors seeking recognition under chapter 15. Although it remains to be seen whether other circuits will weigh in on the issue of chapter 15 eligibility, the Berau opinion demonstrates that courts that follow Barnet may do so with limited success.

]]>Lookback Period: Two Weekshttps://business-finance-restructuring.weil.com/chapter-15/lookback-period-two-weeks-2/
Fri, 18 Sep 2015 17:30:12 +0000http://business-finance-restructuring.weil.com/?p=13666Contributed by Maurice Horwitz From the high-stakes litigation in Caesars to missed deadlines in personal bankruptcy cases, the Weil Bankruptcy Blog served up something for everyone in the first few weeks of September. Here’s a look back at the topics that we covered in the previous two weeks. Judge Scheindlin […]

From the high-stakes litigation in Caesars to missed deadlines in personal bankruptcy cases, the Weil Bankruptcy Blog served up something for everyone in the first few weeks of September. Here’s a look back at the topics that we covered in the previous two weeks.

The Caesars parent guarantee litigation – in which certain debtholders have used the Trust Indenture Act to challenge the release of guarantees by the Ceasars non-debtor parent company – has grabbed the attention of many spectators in the distressed debt arena. In his two-part series, Doron Kenter analyzed Judge Shira Scheindlin’s recent, much-awaited decision on a summary judgment motion brought in this litigation. In part one of Judge Scheindlin Rules in Caesars that Trust Indenture Act Bars “Core” Impairments; Certifies the Issue to the Second Circuit OR What’s the Deal with the Caesars Parent Guarantee Litigation? Doron reviewed the facts of the case, noting that Judge Scheindlin had already concluded that section 316(b) of the TIA “protects more than simply formal, explicit modification of the legal right to receive payment,” which would allow a sufficiently clever issuer to gut the [TIA]’s protections” (internal quotations omitted). But certain open questions remained: What kinds of impairment violate section 316(b) of the TIA, and did the TIA bar the release of the Caesars parent guarantee without first obtaining the consent of each noteholder? The court denied the indenture trustee’s motion for summary judgment, although it did not accept Caesars’ argument that the parent guarantee was merely a “regulatory device” to comply with SEC regulation. As Doron explains in part two of Judge Scheindlin Rules in Caesars that Trust Indenture Act Bars “Core” Impairments; Certifies the Issue to the Second Circuit OR What’s the Deal with the Caesars Parent Guarantee Litigation? the court rejected the indenture trustee’s argument that any impairment violates the TIA. As a general rule, section 316(b) bars informal debt restructurings or nonconsensual amendments to “core terms” of debt instruments. The question was whether any of the transactions at issue rose to such a level. The court concluded that a factual inquiry would be necessary to determine whether the transactions collectively constituted an impermissible out-of-court restructuring. Finally, the court recognized that courts across the country (and even within New York) are divided over the interpretation of section 316(b) of the TIA, and specifically, whether that section only protects noteholders’ legal rights, or also their practical right to payment of principal and interest. Given its importance, and because this question is a pure matter of law, the court certified an immediate interlocutory appeal to the United States Court of Appeals for the Second Circuit to consider the correct interpretation of section 316(b) of the TIA. To be continued.

Switching to channeling injunctions, in Piper Aircraft Bankruptcy Court Gives Parties ‘Crash’ Course in Parameters of Channeling Injunction, Abigail Lerner reported on a recent decision from a not-so-recent case: the case of Piper Aircraft Corporation, whose chapter 11 plan was confirmed more than twenty years ago. The plan provided for the sale of substantially all of the debtor’s assets and for the creation of a trust to address successor liability claims arising in the future. To constitute such a “Future Claim,” the claim must have (a) arisen out of liability based on planes or parts manufactured by the debtor and (b) been based on wrongdoing by the debtor, whether for product liability, design defects, or failure to warn. The purpose of the channeling injunction was to redirect Future Claims to the trust and away from the purchaser of Piper’s assets. The injunction worked well for more than two decades, but in the past year, two lawsuits arose against the purchaser that required the United States Bankruptcy Court for the Southern District of Florida to decide whether certain claims met the definition of a Future Claim under the plan. In one set of lawsuits, the plaintiffs based liability against the purchaser solely upon the purchaser’s alleged failure to warn of a defect unknown to Piper Aircraft, but later known to the purchaser. In another set of lawsuits, the plaintiffs alleged that the purchaser was negligent for failing to update its Pilot’s Operating Handbook despite changes in safety recommendations. As to both sets of complaints, the court held that liability could not be established based on the debtor’s wrongdoing, and therefore were not “Future Claims” that could be channeled to the trust.

Bankruptcy Court Analyzes English and Luxembourgish Insolvency Law – Opts to Take a Cup of Tea With its Decision and Decline Luxembourg’s Eau de Vie

You’ll need to read Yvanna Custodio’s post, Bankruptcy Court Analyzes English and Luxembourgish Insolvency Law – Opts to Take a Cup of Tea With its Decision and Decline Luxembourg’s eau de vie, yourself to learn what Luxembourgish eau de vie is and how it relates to this cross-border dispute arising out of the English liquidation proceeding of Hellas Telecommunications (Luxembourg) II SCA. Here’s a hint: Hellas is a Luxembourgish company, but it moved its “center of main interests” from Luxembourg to the United Kingdom to avail itself of England’s restructuring regime. Ultimately, the company was placed into compulsory liquidation in England, and its joint liquidators sought chapter 15 recognition to sue certain private equity firms that indirectly owned Hellas’s ultimate parent. The United States Bankruptcy Court for the Southern District of New York considered whether to dismiss three claims. First, the bankruptcy court permitted the liquidators to assert fraudulent transfer-type claims, rejecting the defendants’ argument that only the English High Court had jurisdiction. On a close call, the bankruptcy court also let stand the second claim – for fraudulent trading, i.e., carrying on a business with the intent to defraud creditors. The bankruptcy court rejected the defendants’ argument that Luxembourgish law, which has no equivalent fraudulent trading-type claim, should be applied and agreed with the liquidators that English law would apply because England had the greater interest. But the bankruptcy court rejected the third claim – an attempt by the liquidators to confer standing on Hellas’s creditors to bring their own fraudulent transfer actions – because the liquidators failed to submit authority demonstrating that they had standing to bring an action on behalf of a debtor’s creditors. Eau de vie, anyone?

In Our Bad: Bankruptcy Court Denies Creditors’ Motion to Reopen Chapter 7 Case and Vacate Discharge Order Based on Parties’ Mutual Mistake, Matthew Goren reported on a chapter 7 case, in re Fe M. Lavandier, that answers a variant on that age-old zen koan: if litigants enter into a private agreement to change deadlines mandated by statute or rule, but the agreement is not “so ordered” by a court, do the deadlines actually change? To the dismay of the would-be plaintiff in this case, the answer is no. In this case, Envios de Valores La Nacional Corp. (“LAN”) – a licensed money transmitter – moved to reopen the debtor’s chapter 7 case to vacate the discharge order and permit the late-filing of a non-dischargeability complaint against the debtor. A discharge order already had been entered in the case, but LAN argued that the order was entered by mistake because the debtor and LAN previously had entered into a stipulation extending LAN’s deadline to object to the dischargeability of the debtor’s debt to LAN under section 523(a) of the Bankruptcy Code. But there were two holes in LAN’s argument. First, LAN’s attorney filed the executed stipulation with the bankruptcy court, but did not seek to have the court “so order” the stipulation. Accordingly, there was no court order extending the time to object to the debtor’s discharge. It turns out, if parties sign a stipulation to extend statutory deadlines, but the stipulation isn’t “so ordered,” it doesn’t make a sound. Second, the stipulation had one other “fatal” flaw: by its terms, the stipulation had no effect on LAN’s claim that the debtor’s debt was non-dischargeable. It merely purported to extend the deadline to object to the debtor’s general discharge pursuant to section 727(a), and not to prosecute exceptions to discharge of the types listed in section 523(a) of the Bankruptcy Code. As a result, the court concluded that no purpose would be served by reopening the case to permit LAN to file a time-barred claim.

“Conduct” Test Now the Rule in the Seventh Circuit – But We Still Don’t Know How the Seventh Circuit Will Deal With Due Process Concerns

The Seventh Circuit finally weighed in on the issue of when a claim arises in a bankruptcy case, as previously reported in “Conduct” Test Now the Rule in the Seventh Circuit – But We Still Don’t Know How the Seventh Circuit Will Deal With Due Process Concerns. From among the various tests employed by courts across the country – the “conduct” test, “fair contemplation” standard, or “prepetition relationship” rule – the Seventh Circuit chose the “conduct” test, holding that the date a claim arises is determined by the date of the conduct by the debtor that gave rise to the claim. In adopting the “conduct” test, the Seventh Circuit found that all the relevant acts in the case before it occurred prepetition – the legislature’s adoption of a fee payable by hospitals, the approval of the fee by federal regulators and calculation of the entire fee payable by the debtor hospital. The court therefore concluded that the state’s collection of a fee assessed prepetition, but not payable until the debtor hospital’s postpetition fiscal year, constituted an act to collect a prepetition claim and, therefore, violated the automatic stay imposed by section 362(a) of the Bankruptcy Code. Notably, the Seventh Circuit expressly did not decide how it would characterize a claim in the future if the claimant lacked the kind of prepetition relationship that existed between the debtor hospital and the state.

Fail to ‘Notice’ an Objection to Your Proof of Claim? Too Bad Says the Bankruptcy Court

Good lawyers agonize over providing proper notice in any legal proceeding, and with good reason, as Abigail Lerner explained in her discussion of a recent decision by the United States Bankruptcy Court for the District of Colorado in Fail to ‘Notice’ an Objection to Your Proof of Claim? Too Bad Says the Bankruptcy Court. In that chapter 13 case, the debtors filed an objection to a creditor’s proof of claim and served the objection on the creditor at the address specified by the creditor in its proof of claim. The response deadline for the objection came and went with no response by the creditor, so the claim was expunged. The creditor later sought to vacate the court’s judgement under Fed. R. Civ. P. 60(b). The creditor argued that notice of the objection had been deficient because the debtors had not served the objection on an officer, managing agent or general agent, or any other agent, as required by Bankruptcy Rules 9014 and 7004(b)(3). The court ruled against the creditor in two respects. First, the court held that Rule 60(b) was not the correct predicate for relief; instead, the creditor should have sought relief under section 502(j) of the Bankruptcy Code, which allows a court to reconsider the allowance or disallowance of claims “for cause.” Second, and more importantly, the court cited Bankruptcy Rule 2002(g)(1)(A), which states that “a proof of claim filed by a creditor . . . that designates a mailing address constitutes a filed request to mail notices to that address . . . .” Based on this rule, the court found that the creditor had consented to service at the address provided in its proof of claim and knowingly chose not to designate an officer or agent. The court also found that the creditor could not have reasonably expected to receive service anywhere else, having filed a proof of claim with a specific address and no reference to an officer, agent or other representative.

]]>Bankruptcy Court Analyzes English and Luxembourgish Insolvency Law – Opts to Take a Cup of Tea With its Decision and Decline Luxembourg’s eau de vie1https://business-finance-restructuring.weil.com/chapter-15/bankruptcy-court-analyzes-english-and-luxembourgish-insolvency-law-opts-to-take-a-cup-of-tea-with-its-decision-and-decline-luxembourgs-eaux-de-vie1/
Thu, 03 Sep 2015 20:41:11 +0000http://business-finance-restructuring.weil.com/?p=13600Contributed by Yvanna Custodio In resolving a motion for leave to file an amended complaint to add new claims, the United States Bankruptcy Court for the Southern District of New York in Hosking v. TPG Capital Management, L.P. (In re Hellas Telecommunications (Luxembourg) II SCA) delved into a complex analysis […]

In resolving a motion for leave to file an amended complaint to add new claims, the United States Bankruptcy Court for the Southern District of New York in Hosking v. TPG Capital Management, L.P. (In re Hellas Telecommunications (Luxembourg) II SCA) delved into a complex analysis of English and Luxembourgish (yes, that’s a word) insolvency law, and concluded that while two of the English fraud-based claims could proceed, the Luxembourgish claim allowing creditors to attack fraudulent transactions could not.

The plaintiffs, the joint compulsory liquidators and authorized foreign representatives of Hellas Telecommunications (Luxembourg) II SCA, sought to avoid and recover, in an adversary proceeding commenced in the debtor’s chapter 15 case, an initial transfer of approximately €1.57 billion by Hellas II to its parent and subsequent transfers of approximately €974 million to certain private equity firms that owned the sponsors of the ultimate parent. The assailed multi-step transaction (referred to as the “December 2006 Transaction” in the decision) was allegedly aimed at extracting returns from the debtor “under the guise of a purported ‘refinancing’ of its debt.” First, the debtor issued €960 million and $275 million of subordinated notes; second, related Hellas entities issued additional notes, the proceeds of which were transferred to the debtor; third, the debtor transferred a total of approximately €1.57 billion to its parent, around €974 million of which was paid to redeem convertible preferred equity certificates that the ultimate Hellas parent issued a year before. The ultimate Hellas parent was wholly owned by eight investment funds that were, in turn, formed by the private equity firms that were the alleged subsequent transferees in the December 2006 Transaction.

In 2009, the debtor moved its center of main interests from Luxembourg to the United Kingdom in anticipation of a restructuring, was placed into administration by the High Court of Justice of England and Wales, and, in 2011, was placed under compulsory liquidation. In 2012, the case found its way across the pond through a chapter 15 petition for recognition filed in the bankruptcy court.

Unsurprisingly, the private equity firms named as the defendants in the original complaint argued that the amended complaint could not survive a motion to dismiss and would be futile.

First, with respect to the English fraudulent transfer-type claim, the defendants argued that, among other things, the bankruptcy court lacked subject matter jurisdiction over the claim because under English insolvency law, only the English High Court or another court with jurisdiction to wind up the debtor could grant the relief requested. The plaintiffs countered, however, that the section at issue “is a purely procedural English venue statute” and the bankruptcy court would not be bound to apply it. After analyzing the statute and case law, as well as reviewing the declarations of the parties’ experts on English law, the bankruptcy court concluded that it had subject matter jurisdiction over the claim, finding that applicable federal law (and not a foreign statute) determined whether the court had subject matter jurisdiction and whether venue was proper. Although the court observed that it was “bound to apply the substantive law of the UK to adjudicate the [English fraudulent transfer-type claim] . . ., it is not bound to follow UK procedural law.”

Second, with regard to the fraudulent trading-type claim (i.e., carrying on a business with the intent to defraud creditors) the defendants argued that, among other things, Luxembourgish law applies under choice of law principles, but because Luxembourgish law has no equivalent fraudulent trading-type claim, then amending the complaint would be futile because no relief could be granted. Relying on the “interest analysis,” which is the test used in New York to determine which jurisdiction’s law applies to the claim, the plaintiffs argued that England has the “greatest interest in seeing its law applied.” Luxembourg’s relationship to the transfers was “relatively insignificant,” according to the plaintiffs, and they alleged a number of facts showing that the December 2006 Transaction included an English “hook,” such as the location of the planning and execution of the December 2006 Transaction, the transfer of funds involving English bank accounts, and the location of the executives who signed the transaction documents. Acknowledging that the answer was not clear-cut, the bankruptcy court held that the United Kingdom had “the greater interest in having its substantive law govern.” In so holding, the court pointed to the allegations in the complaint demonstrating “that a substantial amount of the actions relating to the December 2006 Transaction were taken by entities and individuals located in countries outside Luxembourg.” Notably, the court observed that the nominal registration status of the Hellas entities in Luxembourg was insufficient to “tip the interest analysis” toward Luxembourgish law.

On the third major issue, the Luxembourgish claim allowing creditors to attack fraudulent transactions, the bankruptcy court found for the defendants that the claim would be futile because the plaintiffs lacked standing. The court agreed with the defendants’ assertion that the claim belonged solely to the debtor’s creditors, observing that the plaintiffs did not submit any authority demonstrating that a receiver or liquidator of a foreign debtor could bring an action on behalf of the creditors in a foreign court.

Although this post only touches upon the meat-and-potatoes of the Hellas decision (a mere crumpet, if you will), the case highlights the vulnerability of a complex, multi-step transaction to fraudulent transfer claims, particularly in light of allegations that the refinancing was merely a way for the investors to realize returns on their investments. If a fraudulent transfer analysis is conducted as part of the diligence process in structuring a transaction, Hellas demonstrates that the relevant inquiry will include not only the law of the jurisdiction in which the debtor is incorporated, but could potentially implicate jurisdictions in which a substantial amount of the actions relating to the transaction took place.

Our end of summer bankruptcy cram course continues today with Part 3 of our Lookback Period.

Where Should the Court Draw the Line on Legal Advice?

In Blurred Lines: Seventh Circuit Keeps Alive Claims Based Upon Law Firm’s Alleged Failure to Advise on Degrees of Business Risk, Matthew Goren discussed the potential effect on restructuring advisors of a decision refusing to dismiss a malpractice action against a law firm. In that case, a chapter 7 trustee commenced a malpractice action against a law firm that had advised now-insolvent hedge funds that had invested in what turned out to be a Ponzi scheme, arguing that the firm had failed to recognize certain “serious red flags” that should have led the firm to advise the hedge funds to seek additional protections in their negotiations with the fraudulent investment scheme. In keeping the action alive, the Seventh Circuit noted that “within the scope of the engagement a lawyer must tell the client which different legal forms are available to carry out the client’s business, and how (if at all) the risks of that business differ with the different legal forms.”

Over the objections of a group of bondholders, Bankruptcy Judge Drain from the Southern District of New York recognized as “foreign main proceedings” the proceedings filed by OAS S.A. and its affiliates in Brazil. In his three-part series, Maurice Horwitz broke down the elements of the court’s decision. In SDNY Sides with Fifth Circuit and the UNCITRAL Model Law when Granting Recognition to OAS S.A. et al., Moe discussed the bankruptcy court’s conclusion that the foreign representative designated by OAS met the definition of “foreign representative” even though he was authorized by OAS’s board, and not the Brazilian court, to act as the representative. The bankruptcy court concluded that the definition of “foreign representative” under section 101(24) of the Bankruptcy Code does not require that a foreign representative by judicially appointed. It also held that, because the OAS debtors retained full control of their assets, subject to the oversight of the judicial administrator, they effectively functioned as debtors in possession with the authority to appoint a foreign representative.

In his second entry, SDNY Holds That Austrian Financing Subsidiary Has Its Center of Main Interests in Brazil, Moe discussed the bankruptcy court’s conclusion that Brazil was the center of main interests (“COMI”) of OAS’s Austrian subsidiary, which happened to be the issuer of the notes held by the creditors challenging recognition. Notwithstanding the presumption that a debtor’s COMI is located where the debtor’s registered office is located, the bankruptcy court found that the Austrian subsidiary was a special purpose financing entity that did not conduct business, own assets, have a physical location, or employ anyone in Austria. Moreover, the Austrian subsidiary’s only business was to issue the notes. Accordingly, the bankruptcy court found that Brazil was the “nerve center” of the OAS entities, including the Austrian financing subsidiary.

Finally, in SDNY Takes Narrow View of Chapter 15’s Public Policy Exception, Moe focused on the bankruptcy court’s rejection of the noteholders’ argument that the bankruptcy court should deny recognition of OAS’s Brazilian bankruptcy proceedings because certain aspects of Brazilian bankruptcy law, or the Brazilian proceedings themselves, are “manifestly contrary” to U.S. public policy. This argument arises under section 1506 of the Bankruptcy Code, which permits the bankruptcy court to refuse to take an action under chapter 15 if such “action would be manifestly contrary to the public policy of the United States.” The bankruptcy court, however, noted the U.S. courts have interpreted section 1506 narrowly and found that, notwithstanding the noteholders’ expressed concerns about a lack of due process in the Brazilian proceedings, given the U.S. courts’ narrow interpretation of section 1506, the ability of the noteholders to seek further judicial review of certain ex parte orders of the Brazilian court, and that some concerns were simply speculation about what might happen in the Brazilian proceeding, the proposed actions were not manifestly contrary to U.S. public policy.

A Default Is a Default, and Reinstatement Doesn’t Change That

Alana Heumann examined the effect of reinstatement of a debt under section 1123 of the Bankruptcy Code on a lender’s ability to claim default interest in The Cure: Eleventh Circuit Entitles Lender to Default Rate Interest. In In re Sagamore Partners, the Eleventh Circuit rejected the debtor’s argument that it need not pay accrued default interest as a condition to reinstatement of a loan under the debtor’s plan. In so holding, the Eleventh Circuit relied upon the language of section 1123(d) of the Bankruptcy Code, which requires the debtor to cure defaults in accordance with the terms of the underlying documents and applicable non-bankruptcy law. The Eleventh Circuit also upheld the lender’s right to assert alternative remedies—here, late fees – and held that the lender did not waive its claim to interest by asserting a (later withdrawn) claim for late fees.

Katherine Doorley discussed two decisions on “lien stripping” – avoiding a lien to the extent the value of the collateral is less than the lienholder’s interest – in Two New Decisions Appear to Support Lien Stripping (Under Certain Conditions). In Boukatch v. Midfirst (In re Boukatch), the Ninth Circuit BAP held that a lien can be stripped following a chapter 13 debtor’s payment of all amounts payable under his or her plan even if the individual debtor is not eligible for a discharge. In In re John Paul Smith, Kate discussed a decision of the U.S. Bankruptcy Court for the Eastern District of North Carolina that somehow conditioned confirmation of an individual chapter 11 debtor’s plan upon making all payments required by the plan (a condition not satisfied by Mr. Smith). The decision, however, might be read to suggest that, if Mr. Smith had made all his payments, he could have stripped an underwater secured creditor’s lien.

The Burden of the Bundle in Section 365

A number of ostensibly conflicting principles guide assumption or rejection of executory contracts under section 365 of the Bankruptcy Code – a debtor may not cherry pick provisions in a contract (i.e., it must assume or reject a contract in toto), but a single contract that is really multiple contracts might be severable. What happens when the parties expressly state that multiple contracts should be treated as one? That was the issue addressed in Delaware, and discussed by Jessica Diab, in It’s All or Nothing: Delaware District Court Says Debtor Cannot Pick and Choose From Bundle of Related Agreements!After determining that a software license agreement was assumable notwithstanding section 365(c)(1) of the Bankruptcy Code because the agreement allowed for the assignment, the Delaware District Court nevertheless held that, if the debtor wanted to assume a software license, it also was required to assume a number of related agreements because all of the agreements were intended to be part of an integrated bundle. In so ruling, the district court held that agreements need not even be executed simultaneously to form part of an integrated contract. Among other things, the reference among the agreements to other agreements and incorporation of each other’s terms led the court to conclude that the parties intended for the related agreements to be treated as one integrated agreement.

Believe It or Not, But Manville Continues to Generate Decisions

Johns-Manville emerged from its historic chapter 11 case in 1988, but its legacy continues – not just in the use of 524(g) injunctions patterned after those of Manville and other early asbestos debtor pioneers, but also in disputes that have continued to work their way through the judicial system. Abigail Lerner addressed the latest such decision in SDNY Bankruptcy Court Says Claims Against Insurer Need Not Be “Inextricably Intertwined” with Insurer’s Relationship with Debtor to Fall Within Scope of Channeling Injunction. In a ruling that likely has relevance to the interpretation of channeling injunctions under section 524(g) of the Bankruptcy Code, the Bankruptcy Court for the Southern District of New York ruled that so-called “independent” claims asserted against Manville’s insurance broker were barred by the channeling injunction in the Manville plan and confirmation order because they were “related to” the services provided by the broker to Manville. The bankruptcy court rejected the claimant’s argument that the broker was required to show that the claims were “inextricably intertwined” with the broker’s relationship with Manville to be protected under the channeling injunction.

]]>OAS S.A. Part III – SDNY Takes a Narrow View of Chapter 15’s Public Policy Exceptionhttps://business-finance-restructuring.weil.com/chapter-15/oas-s-a-part-iii-sdny-takes-a-narrow-view-of-chapter-15s-public-policy-exception/
Thu, 06 Aug 2015 00:16:30 +0000http://business-finance-restructuring.weil.com/?p=13438Contributed by Maurice Horwitz Last week, we reviewed the recent decision of the Bankruptcy Court for the Southern District of New York that granted recognition to the Brazilian bankruptcy proceedings of three entities in the OAS Group (“OAS”), a Brazilian infrastructure enterprise. Part I of this series focused on the […]

Last week, we reviewed the recent decision of the Bankruptcy Court for the Southern District of New York that granted recognition to the Brazilian bankruptcy proceedings of three entities in the OAS Group (“OAS”), a Brazilian infrastructure enterprise. Part I of this series focused on the facts of the OAS cases and the objections to recognition interposed by two significant holders (the “Noteholders”) of OAS’s aggregate $875 million senior notes due 2019 (the “2019 Notes”). We also analyzed in closer detail the Noteholders’ argument that Renato Fermiano Tavares was not qualified to serve as OAS’s “foreign representative,” as that term is defined by the Bankruptcy Code. In Part II, we examined the bankruptcy court’s holding that OAS’s Austrian financing subsidiary actually has its center of main interests in Brazil.

In this final post, we briefly consider the Noteholders’ third objection – that the bankruptcy court should deny recognition of OAS’s Brazilian bankruptcy proceedings because certain aspects of Brazilian bankruptcy law, or the Brazilian proceedings themselves, are “manifestly contrary to public policy.”

The Public Policy Exception

Chapter 15 is equipped with a “safety valve” known as the public policy exception. Section 1506 of the Bankruptcy Code provides:

Nothing in this chapter prevents the court from refusing to take an action governed by this chapter if the action would be manifestly contrary to the public policy of the United States.

[n]othing in this Law prevents the court from refusing to take an action governed by this Law if the action would be manifestly contrary to the public policy of this State.

Chapter 15 also provides that

[i]n interpreting this chapter, the court shall consider its international origin, and the need to promote an application of this chapter that is consistent with the application of similar statutes adopted by foreign jurisdictions.

While chapter 15’s stated purpose is “to provide effective mechanisms for dealing with cases of cross-border insolvency,” often the practical result of these “mechanisms” is to extend the reach of foreign bankruptcy proceedings into the territorial United States of America. The public policy exception ensures that chapter 15 cannot require U.S. courts to run roughshod over fundamental U.S. policies.

This may seem powerful, but the public policy exception is rarely employed by courts. As the bankruptcy court noted, the Second Circuit has taken a “narrow reading” of section 1506. This narrow reading is based on international usage rather than any trend in U.S. case law. When the Second Circuit first considered the application of section 1506, in Fairfield Sentry, the Court stated, citing the House Report, that Article 6 of the Model Law

is standard in UNCITRAL texts, and has been narrowly interpreted on a consistent basis in courts around the world. The word “manifestly” in international usage restricts the public policy exception to the most fundamental policies of the United States.

The Second Circuit also relied on the Guide To Enactment Of The UNCITRAL Model Law Of Cross-Border Insolvency (the “Guide”) promulgated by UNCITRAL, which states that “the exception should be read ‘restrictively’ and invoked only ‘under exceptional circumstances concerning matters of fundamental importance for the enacting State.’” Given this reading, arguments based on the public policy exception are generally difficult to win.

The Noteholders’ Arguments

Despite these odds, the Noteholders argued that recognition of the OAS cases would be manifestly contrary to public policy. Their argument centered on the December 2014 transactions discussed in Part I of this series. The Noteholders have alleged that as a result of these transactions, certain OAS subsidiaries who guaranteed the 2019 Notes either transferred assets to, or were merged with, non-guarantors in the OAS enterprise, thus diluting the assets available for Noteholder recoveries. In objecting to recognition before the bankruptcy court, the Noteholders argued that the Brazilian Court ordered a “substantive consolidation” order on an ex parte basis, thus robbing the Noteholders of due process; and furthermore, because “the Brazilian plan will likely be based on substantive consolidation,” any fraudulent transfer actions that the Noteholders endeavored to pursue would be pointless. For these reasons, the Noteholders argued, distributions under the Brazilian plan would deviate materially from the distributions that would occur in the U.S (where, presumably, substantive consolidation would not be granted, and the Noteholders would be free to pursue their fraudulent transfer claims).

After noting that “Brazil has a comprehensive bankruptcy law that in many ways mirrors our own,” the bankruptcy court rejected the Noteholders’ arguments. Specifically, the bankruptcy court rebutted the Noteholders’ due process argument by stating that the Brazilian court’s substantive consolidation order has not been “definitively granted” – a fact that the Noteholders conceded. So, the Noteholders would have an opportunity to challenge substantive consolidation at a later time. The bankruptcy court also compared the Brazilian court’s ex parte order to other types of orders that U.S. courts routinely grant on an ex parte basis, e.g., for Rule 2004 examinations or temporary restraining orders. “Due process is satisfied,” according to the bankruptcy court, “because these ex parte proceedings and orders are subject to ex post review, just as the consolidation order has been subject to ex post review in Brazil.”

The Noteholders’ arguments were also premised on the premature assumption that the Brazilian court will approve a substantive consolidation plan that moots the Noteholders’ fraudulent transfer claims. According to the bankruptcy court,

Objections based on the speculation that the Brazilian Court will approve a plan or plans that permit substantive consolidation, unfair distributions or the elimination of creditor fraudulent transfer claims are premature. They depend on the contents and effect of one or more plans that the Brazilian Court has not yet approved and may never approve.

In other words, the Noteholders are not without a remedy – they should still have an opportunity to challenge substantive consolidation and the elimination of their fraudulent transfer claims. In fact, they may even have two opportunities to raise this challenge. The first would be at the plan approval stage in Brazil, when the issue is ripe for the Brazilian court to consider. And even if they lose in Brazil, they may have a second chance in New York, if OAS seeks to enforce the terms of its Brazilian restructuring plan in the U.S. through its chapter 15 case, as Rede Energia did (see our post on the Rede case here).

Conclusions

Is the bankruptcy court signaling that the Noteholders should try their public policy arguments later, when OAS seeks a chapter 15 enforcement order? This seems unlikely; the bankruptcy court telegraphed how it would view such an objection, stating that “even a ‘definitive’ substantive consolidation order is not manifestly contrary to United States law,” and adding that “[a]lthough Brazilian law may impose different requirements for substantive consolidation, the different standards, standing alone, do not signify that Brazilian Bankruptcy Law is manifestly contrary to public policy.”

Nevertheless, in concluding that recognition is not manifestly contrary to the public policy of the United States, the court added this qualification:

This conclusion is without prejudice to [the Noteholders’] right to challenge any action that [the foreign representative] seeks to take in this Court, including, in particular, a request to recognize and enforce a plan or plans approved by the Brazilian Court.

In opposing recognition, the Noteholders have deployed many of the same arguments as were raised by the noteholders in In re Vitro S.A.B. de C.V. If the Noteholders continue to follow the Vitro playbook, then it is likely that their challenge to the Brazilian restructuring plan will be much broader than the public policy exception. In Vitro, the Fifth Circuit declined to consider the public policy exception as a basis for denying enforcement to a Mexican concurso plan. But that is because the Fifth Circuit found other reasons to block the plan’s enforcement, as we covered here. As noted above, the Noteholders have argued that substantive consolidation, combined with the December 2014 transactions, will ultimately yield a distribution outcome that deviates materially from the distributions that would occur in the U.S. The bankruptcy court rejected this argument for purposes of granting recognition, but the same argument, which resonated with the Fifth Circuit in Vitro, could be renewed if OAS seeks enforcement of its restructuring plan through the chapter 15 case.

It is worth noting, finally, that the Noteholders also accused OAS’s foreign representative of “refus[ing] to cooperate in discovery,” and evidencing “a disregard for United States process.” The bankruptcy court disagreed, finding these allegations unsupported by the record. While a win for OAS, this detail highlights one of the potential downsides of seeking chapter 15 relief – U.S. law and procedure offer creditors and other interested parties a powerful set of tools for obtaining leverage. If the benefits outweigh the costs, then opening a second front in your restructuring battles makes sense. We will continue to monitor the OAS cases and provide our thoughts on this cost-benefit analysis as the cases progress.

]]>OAS S.A. Part II – SDNY Holds That Austrian Financing Subsidiary Has Its Center of Main Interests in Brazilhttps://business-finance-restructuring.weil.com/chapter-15/oas-s-a-part-ii-sdny-holds-that-austrian-financing-subsidiary-has-its-center-of-main-interests-in-brazil/
Tue, 28 Jul 2015 15:30:34 +0000http://business-finance-restructuring.weil.com/?p=13393Contributed by Maurice Horwitz On July 13, 2015, the Bankruptcy Court for the Southern District of New York granted recognition to the Brazilian bankruptcy proceedings of three entities from The OAS Group (“OAS”), a Brazilian infrastructure enterprise. Recognition was granted over the objection of two significant holders (the “Noteholders”) of […]

On July 13, 2015, the Bankruptcy Court for the Southern District of New York granted recognition to the Brazilian bankruptcy proceedings of three entities from The OAS Group (“OAS”), a Brazilian infrastructure enterprise. Recognition was granted over the objection of two significant holders (the “Noteholders”) of OAS’s aggregate $875 million senior notes due 2019 (the “2019 Notes”). In a three-part series, the Weil Bankruptcy Blog is examining the court’s ruling in detail. Part I of this series reviewed the facts of the case and examined the court’s decision that Renato Fermiano Tavares qualified to serve as OAS’s “foreign representative,” as that term is defined by the Bankruptcy Code. In today’s blog post, we will consider the court’s decision to grant recognition – as a foreign main proceeding – to OAS’s Austrian subsidiary, OAS Investments GmbH (“Investments”), the issuer of the 2019 notes. Part III will consider the court’s decision not to invoke the public policy exception for OAS.

This was not the case in Brazil until recently. Prior to the bankruptcy cases of the OGX Petróleo e Gás Participações S.A. and its affiliates (“OGX”), it was assumed that a corporate group with financing subsidiaries incorporated outside of Brazil would not be able to include such entities in their Brazilian bankruptcy filing. And indeed, when OGX first filed in Brazil, the court of first instance held that OGX’s Austrian financing subsidiary, OGX Austria GmbH, should be excluded from the bankruptcy filing. The Brazilian Court of Appeals, however, reversed the decision and held that the Austrian financing subsidiary should be added to the filing. This was a surprising and very significant development in Brazilian bankruptcy law when it occurred in February of this year.

OAS Investments GmbH

Given this new precedent, it was less surprising when the Brazilian court overseeing OAS’s bankruptcy proceedings held that Investments could file for bankruptcy protection in Brazil along with the rest of the group. In the words of the U.S. bankruptcy court:

The Brazilian Court observed that although Brazil had not yet adopted the UNCITRAL Model Code, the center of main interests of OAS was Brazil, and the Brazilian Debtors, including those incorporated abroad, were part of the same economic group controlled from Brazil.

As the issuer of the 2019 Notes, it was essential that Investments be able to join its affiliates as a debtor in the Brazilian bankruptcy proceedings. It was equally important, for purposes of the chapter 15 cases, that the bankruptcy court in New York recognize the Brazilian proceeding for Investments as a foreign main proceeding (i.e., as a proceeding pending in a country where the debtor’s center of main interests (“COMI”) is located), as opposed to a foreign non-main proceeding (i.e., a proceeding pending in a country where the debtor has an establishment, but no COMI). Recognition as a foreign main proceeding confers considerably greater benefits to a foreign debtor, including the authority to manage the debtor’s business in the ordinary course, and immediate imposition of the “automatic stay” and other provisions of the Bankruptcy Code on property of the debtor located within the United States.

To recognize Investments’ proceeding as a foreign main proceeding, the bankruptcy court needed to find that Investments’ COMI was in Brazil as of the time of the filing of the chapter 15 petition. There is a presumption under chapter 15 that a debtor’s registered office is located in that debtor’s COMI. But the presumption can be rebutted based on a court’s consideration of “any relevant activities” of the debtor, including the location of the debtor’s headquarters, who actually manages the debtor, the location of the debtor’s assets and creditors, and the jurisdiction and law that would apply to most disputes. In addition, the Second Circuit has held that a court may consider the debtor’s “nerve center,” “including from where the debtor’s activities are directed and controlled, in determining a debtor’s COMI.”

The Bankruptcy Court’s Analysis

The bankruptcy court acknowledged that “COMI analysis when applied to a special purpose financing vehicle proves less straightforward than the typical case.” Despite its maintaining its registered office in Vienna, however, the bankruptcy court noted that Investments “does not conduct business, own assets, have a physical location, or employ anyone in Austria.” Its “predominant creditors,” the holders of the 2019 notes, are “located worldwide.” And Investments had “no other business” than paying off the 2019 notes – an objective that could only be met, according to the bankruptcy court, through the Brazilian bankruptcy proceedings of OAS (“In truth, the only source of repayment that will ultimately discharge the obligations to the 2019 Noteholders must come from the OAS Group pursuant to the reorganization of their financial affairs.”) For these reasons, the bankruptcy court found that Brazil was Investments’ COMI and “nerve center.”

The bankruptcy court found additional support in the expectation of Investments’ creditors. Investments’ offering memoranda explained that all of Investments’ directors and officers resided in Brazil and that the notes were guaranteed by OAS S.A. (the parent) and other Brazil-based affiliates. The memoranda also highlighted that Investments was a special purpose financing vehicle within Brazil-based OAS. According to the bankruptcy court, the purchasers of the notes

expected to receive repayment from the cash generated by the operations of the OAS Group, and in the event of a default, might ultimately have to enforce their rights in a Brazilian bankruptcy proceeding. OAS Investments had no separate, ascertainable presence in Austria; it was part of, and inseparable from, the OAS Group located in Brazil.

Having concluded that Investments’ COMI was in Brazil at the time of its chapter 15 filing, the bankruptcy court was able to recognize the Brazilian bankruptcy proceeding as a foreign main proceeding.

Conclusion

The bankruptcy court in New York has therefore made it possible for a special purpose entity registered in Austria, with its COMI and a pending bankruptcy proceeding in Brazil, to obtain the benefits of the automatic stay and other provisions of the U.S. Bankruptcy Code. The protections of chapter 15 are limited, however, to the territorial United States. The benefits that OAS ultimately reaps from chapter 15 recognition remain to be seen, and will depend on the outcome of the Brazilian proceedings and the enforceability of a Brazilian restructuring plan in the U.S. Beyond the OAS cases, the bankruptcy court’s analysis and conclusions with respect to Investments are likely to provide helpful guidance for other foreign debtors with similar special purpose financing subsidiaries.

]]>SDNY Sides with Fifth Circuit and the UNCITRAL Model Law when Granting Recognition to OAS S.A. et al.https://business-finance-restructuring.weil.com/chapter-15/sdny-sides-with-fifth-circuit-and-the-uncitral-model-law-when-granting-recognition-to-oas-s-a-et-al/
Mon, 27 Jul 2015 21:30:52 +0000http://business-finance-restructuring.weil.com/?p=13382Contributed by Maurice Horwitz On July 13, 2015, the Bankruptcy Court for the Southern District of New York issued its decision in In re OAS S.A. et al. that recognized, as foreign main proceedings, three Brazilian bankruptcy proceedings currently pending for The OAS Group (“OAS”) – a Brazilian construction and […]

On July 13, 2015, the Bankruptcy Court for the Southern District of New York issued its decision in In re OAS S.A. et al. that recognized, as foreign main proceedings, three Brazilian bankruptcy proceedings currently pending for The OAS Group (“OAS”) – a Brazilian construction and engineering enterprise. The bankruptcy court granted recognition over the objections of two major noteholders, Aurelius Capital Management, L.P. (“Aurelius”) and Alden Global Capital LLC (“Alden” and, together with Aurelius, the “Noteholders”), who argued that:

with respect to one of the OAS entities seeking recognition – an Austrian financing subsidiary – its “center of main interests” (“COMI”) was not Brazil, and thus, its proceeding could not be recognized as a foreign main proceeding; and

recognition should be denied on the grounds that it would be “manifestly contrary to public policy.”

The bankruptcy court disagreed with the Noteholders on all three points. In Part I of this series, we will review the facts of the case and how the bankruptcy court determined that Tavares satisfied the Bankruptcy Code’s definition of “foreign representative.” In Part II, we will focus on the bankruptcy court’s COMI discussion and consider its implications in future cases involving so-called “financing companies” or “fincos,” whose sole purpose is to issue debt that is on-lent to its affiliates. Finally, in Part III, we will review the bankruptcy court’s analysis of the public policy exception and consider how it adds to the case-law that has developed on this issue.

The OAS Group

OAS is an infrastructure enterprise headquartered in Brazil and engaged in engineering and construction projects across Latin-America, the Caribbean, and Africa. OAS has become better known in restructuring circles as one of the enterprises implicated in “operation car wash” (lava-jato) – a government anti-corruption investigation in Brazil involving the state-owned oil company Petrobras and certain of its contract counterparties.

In October 2012, OAS Investments GmbH (“Investments”), an Austria-based financing subsidiary, issued $500 million of 8.25% senior notes due 2019 (the “2019-1 Notes”). The 2019-1 notes were guaranteed by (i) OAS S.A., the parent company, (ii) Construtora OAS S.A. (“Construtora”), the holding company of OAS’s engineering division, and (iii) OAS Investimentos, S.A (“Investimentos”) (not to be confused with Investments, a separate entity). In October 2014, Investments issued another $375 million of 8.25% notes due 2019 (the “2019-2 Notes” and, together with the 2019-1 Notes, the “2019 Notes”) with guarantees from OAS S.A., Constructora, and Investimentos. Both series of notes were governed by New York law. The proceeds of the 2019 Notes were to be used for refinancing and general corporate purposes of OAS.

On November 21, 2014, after the commencement of “operation car wash,” Petrobras announced that it was temporarily blocking certain companies from competing for new contracts with it. OAS was one of 23 of such firms. Together with a general slowdown in the Brazilian economy, these events created a cash crunch for OAS and made it increasingly difficult for it to obtain credit.

The December 2014 Transactions and Subsequent Litigation

In December 2014, OAS engaged in three transactions that the Noteholders have objected to both in the Brazilian and various U.S. proceedings:

Constructora, a guarantor of the 2019 Notes, transferred R$301 million of assets to another OAS affiliate, OAS Engenharia e Construção S.A., which is not a guarantor of the 2019 Notes;

Investimentos, a guarantor of the 2019 Notes, merged with OAS, another guarantor of the 2019 Notes, pursuant to an agreement that contemplated the subsequent dissolution of Investimentos (thus, according to Aurelius and Alden, eliminating their structural seniority in the separate assets of Investimentos); and

Investimentos also transferred its ownership in Investimentos e Participações em Infraestrutura S.A. (“Invepar”) to its subsidiary OAS Infraestrutura, also not a guarantor of the 2019 Notes.

In response to these transactions and the subsequent default under the 2019 Notes, Aurelius and Alden commenced actions on February 4, 2015 and February 18, 2015, respectively, in New York state court, seeking to recover an aggregate of $140 million due to them under the 2019 Notes. An affiliate of Aurelius, Huxley Capital Corporation, also commenced an action in the District Court for the Southern District of New York seeking to unwind the three December transactions as fraudulent transfers.

The Brazilian Bankruptcies and Chapter 15 Petitions

On March 31, 2015, OAS S.A., Construtora, and Investments (the “OAS Debtors”), together with certain other OAS affiliates, filed for bankruptcy protection in Brazil. On April 2, 2015, the board of directors of the OAS Debtors granted Renato Fermiano Tavares with power of attorney for one year to represent the entities in their Brazilian reorganization proceedings. The Boards of Directors also specifically appointed Tavares as the OAS Debtors’ attorney and agent-in-fact for purpose of seeking relief under chapter 15 of the U.S. Bankruptcy Code. On April 15, 2015, the OAS Debtors filed chapter 15 petitions for recognition and sought an injunction against the New York litigation described above.

The Noteholders opposed recognition. In their objection, they relied upon on three subsections of Bankruptcy Code section 1517 (emphasized in bold below), which state that:

(a) Subject to section 1506, after notice and a hearing, an order recognizing a foreign proceeding shall be entered if—

(1) such foreign proceeding for which recognition is sought is a foreign main proceeding or foreign nonmain proceeding within the meaning of section 1502;

(2) the foreign representative applying for recognition is a person or body; and

(3) the petition meets the requirements of section 1515.

The Noteholders’ objection focused on (i) the public policy exception, provided for in section 1506 (permitting a court to refuse to take action “manifestly contrary to public policy”), (ii) the qualification of Investments’s foreign proceeding as a foreign main proceeding, and (iii) Tavares’s qualification as a foreign representative. We will cover Tavares’s qualification as a foreign representative here, and delve into the other two elements of section 1517 in Parts II and III of this series.

Tavares’s Qualification as Foreign Representative

The Noteholders challenged Tavares’s application for recognition on the grounds that he was not qualified to be a “foreign representative,” as that term is defined in the Bankruptcy Code. Section 101(24) provides that

The term “foreign representative” means a person or body, including a person or body appointed on an interim basis, authorized in a foreign proceeding to administer the reorganization or the liquidation of the debtor’s assets or affairs or to act as a representative of such foreign proceeding.

Specifically, the Noteholders argued that:

Tavares needed to be authorized by a Brazilian Court, not just a board of directors, to act as a foreign representative;

even if a board of directors can appoint a foreign representative, the OAS Debtors are not debtors in possession and thus lacked authority to appoint Tavares and their foreign representative; and

Tavares himself is personally not qualified to be a foreign representative.

With respect to judicial authorization, the court noted that the very same argument had been raised by the objecting noteholders in In re Vitro SAB de CV and rejected by the Fifth Circuit Court of Appeals. Although the Bankruptcy Code’s definition of “foreign representative” includes a requirement that the representative be “authorized in a foreign proceeding,” the court was persuaded by the Fifth Circuit’s holding in Vitro that the phrase “authorized in a foreign proceeding” is ambiguous, and could be read to mean “authorized in the context of a foreign proceeding. The court also noted that the District Court for the Southern District of New York had affirmed at least one prior New York decision in which the bankruptcy court held that a debtor in possession in a Mexican bankruptcy proceeding could authorize a person to act as its foreign representative in a chapter 15 case.

The bankruptcy court found further support for this argument in sources outside of the Bankruptcy Code and U.S. case law. As readers of the blog know from prior articles, chapter 15 incorporates the Model Law on Cross-Border Insolvency (the “Model Law”) promulgated by the United Nations Commission on International Trade Law (“UNCITRAL”). Because it is based on a model law promulgated by the United Nations, section 1508 of the Bankruptcy Code provides:

In interpreting this chapter, the court shall consider its international origin, and the need to promote an application of this chapter that is consistent with the application of similar statutes adopted by foreign jurisdictions.

11 U.S.C. § 1508. The bankruptcy court noted, as other courts have held, that “[a]s each section of Chapter 15 is based on a corresponding article in the Model Law, if a textual provision of Chapter 15 is unclear or ambiguous, the Court may then consider the Model Law and foreign interpretations of it as part of its ‘interpretive task.’” Furthermore, the court added that “[w]hen interpreting Chapter 15, the Court should also consult the Guide To Enactment Of The Uncitral Model Law Of Cross-Border Insolvency (the “Guide”) promulgated by UNCITRAL.

With this in mind, the bankruptcy court (following the Fifth Circuit in Vitro) found additional support for its interpretation of Bankruptcy Code section 101(24) in the Model Law and the reports of the Working Group on Insolvency Law (the “Working Group”). Observing that “[t]he definition of foreign representatives in § 101(24) is essentially identical to the corresponding definition in Model Law Article 2(d).1,” the court cited the Vitro court: “In drafting this definition, the Working Group expressly rejected the requirement that a foreign representative be specifically authorized by statute or other order of court (administrative body) to act in connection with a foreign proceeding.” Relying upon these Working Group texts, the bankruptcy court rejected the Noteholders’ interpretation of “authorized in a foreign proceeding” and, in line with the Fifth Circuit, held that judicial authorization was not required.

Even if judicial authorization was not required, the Noteholders argued that the OAS Debtors’ could not appoint their own foreign representative because they are not debtors in possession. Here again, the court relied primarily on the Model Law and its ancillary texts, stating that “the Model Law does not define the characteristics of a debtor in possession” but “the Guide suggests that it includes a debtor that retains ‘some measure of control over its assets’ although under court supervision.” Accordingly, the court found that the OAS Debtors are debtors in possession within the meaning of the Model Law because the OAS Debtors retain full control of their business and assets, subject to the oversight of a judicial administrator. The Noteholders endeavored to argue that the OAS Debtors are not debtors in possession because they do not have the same exact duties and responsibilities as a U.S. bankruptcy trustee, but the bankruptcy court rejected this argument (as did the Fifth Circuit in Vitro) and noted, citing Vitro, that such an argument

proceeds from the incorrect assumption that only those who meet the criteria of a debtor-in-possession under U.S. law can be deemed a debtor-in-possession in a foreign proceeding with the power to appoint a foreign representative. The drafters of the Model Law did not base their concept of “debtor in possession” on how United States law defined the term, and “under Chapter 15 the correct analogy is not to whether a debtor meets Chapter 11’s definition of a ‘debtor in possession,’ but whether it meets that definition originally envisioned by the drafters of the Model Law and incorporated into § 101(24).”

Finally, the Noteholders argued (among other more technical arguments that the bankruptcy court rejected) that Tavares himself does not fit the definition of a “foreign representative” because, among other things, he has not assumed the duties of administering the assets and affairs of the OAS Debtors, is not neutral and accountable (here, the Noteholders were focused specifically on Tavares’s role in the December transactions), and is not a representative of the Brazilian Court. Finding no guidance in the Bankruptcy Code, the bankruptcy court turned, again, to the Guide, which states that “the foreign representative may be a person authorized in the foreign proceeding to administer those proceedings, which would include seeking recognition, relief and cooperation in another jurisdiction….” Tavares was expressly authorized to do just that – administer the Brazilian bankruptcy proceedings and seek chapter 15 recognition and relief – and thus could satisfy the definition of “foreign representative.”

Conclusion

The bankruptcy court has added to the growing body of case law in New York and elsewhere that grounds its application of chapter 15 firmly in the Model Law and its ancillary texts, none of which were drafted by elected legislators or courts of the United States. In Parts II and III, we will consider how the bankruptcy court’s rulings on COMI and the public policy exception have added further clarity for foreign debtors whose restructuring efforts include the need to seek the assistance of the United States courts through chapter 15 of the Bankruptcy Code.

]]>Bankruptcy Court Decision Sheds Light on Cross-Border Eligibility, Venue, and COMI Issues (Part Two)https://business-finance-restructuring.weil.com/chapter-15/bankruptcy-court-decision-sheds-light-on-cross-border-eligibility-venue-and-comi-issues-part-two/
Fri, 12 Dec 2014 14:53:02 +0000http://business-finance-restructuring.weil.com/?p=12019Contributed by Yvanna Custodio In the first part of our two-part series on In re Suntech, we discussed the bankruptcy court’s ruling that Suntech was eligible to be a debtor under the Bankruptcy Code and that venue was proper in the Southern District of New York because of a bank […]

In the first part of our two-part series on In re Suntech, we discussed the bankruptcy court’s ruling that Suntech was eligible to be a debtor under the Bankruptcy Code and that venue was proper in the Southern District of New York because of a bank account established in New York on the eve of the chapter 15 filing. We noted the implications of the decision for bankruptcy professionals handling cross-border cases, and that, among other things, the court’s interpretation of section 109(a) of the Bankruptcy Code (which sets forth the standard for a debtor’s eligibility) offers a more “open border” policy for foreign companies wishing to commence a chapter 15 case, and arguably a chapter 11 case, in the United States. In today’s post, we discuss the bankruptcy court’s center of main interests (COMI) analysis in addressing Solyndra’s argument that the foreign administrators had manipulated COMI to the Cayman Islands in bad faith.

Section 1502(4) of the Bankruptcy Code introduces COMI as the basis for classifying a foreign proceeding as a “foreign main proceeding,” which would entitle such proceeding to chapter 15 recognition, and provide the foreign debtor with certain rights unavailable to a foreign debtor whose foreign proceeding is merely a “foreign nonmain proceeding.” Unless there is evidence to the contrary, a debtor’s registered office is presumed to be its COMI.

After noting that “[t]he answer is not obvious in a case like this,” the bankruptcy court held that the commencement of the Cayman Islands provisional liquidation and the activities of the foreign administrators successfully transferred the debtor’s COMI from China, where the debtor had historically listed its principal executive offices, to the Cayman Islands. It observed that, although the order appointing the foreign administrators left management of the debtor’s business to the board of directors, in practice, the board exercised “little day-to-day authority.” Notably, the order authorized the foreign administrators to develop and propose a compromise or arrangement with the debtor’s creditors, file a chapter 15 petition in the United States, and exercise “a host of additional powers,” including exercise control over the debtor’s operating subsidiaries. Moreover, prior to the filing of the chapter 15 petition, the foreign administrators took appropriate steps to centralize the administration of the debtor’s affairs in the Cayman Islands. The court also rejected the notion that the creditors expected a restructuring in China, given that they had described it as “the last place that one would want to go.”

Assuming that the Cayman Islands was the debtor’s COMI when the chapter 15 case was filed, Solyndra argued that the foreign administrators manipulated the COMI in bad faith, pointing to, among other things, the transfer of stock certificates, shareholder registries, and statutory records to the Cayman Islands. The court declined to find bad faith, however, noting that the actions of the foreign administrators in making such transfers, as well as conducting a board meeting in the Cayman Islands and establishing a Cayman Islands bank account, were all consistent with the duties of the foreign administrators.

A Spotlight on COMI

The Suntech court’s holding on COMI highlights the ability of foreign administrators to shift a debtor’s COMI from one jurisdiction to another, provided such shift is in furtherance of the debtor’s restructuring and is consistent with the order appointing the foreign administrators. Given that chapter 15 provides recognition to a foreign main proceeding (which could impact the treatment of a foreign debtor’s U.S. assets), the Suntech decision could be relied upon by some as a case study in how to shift COMI from a jurisdiction that is perceived to be less debtor-friendly to one that is perceived to be more so.

Businesses with a global footprint require agile, sophisticated counsel possessing in-depth knowledge of the international aspects of bankruptcy and restructuring. The bankruptcy court decision in Suntech Power Holdings highlights the issues of debtor eligibility under the Bankruptcy Code and the appropriate venue for a chapter 15 case of one such global business: a multi-national group of corporations focused on solar energy. In our two-part series, we first turn our spotlight on the court’s ruling that Suntech was eligible to be a debtor under the Bankruptcy Code and that venue was proper in the Southern District of New York because of a bank account established in New York on the eve of the chapter 15 filing. Tomorrow, we will focus on the court’s center of main interests (COMI) analysis, including whether the activities of the foreign administrators transferred COMI from China (where the debtor listed its principal executive offices as being located) to the Cayman Islands (where the provisional liquidation was commenced).

The Cross-Border Proceedings

Prior to the commencement of the Cayman Islands provisional liquidation, the debtor’s principal executive offices were located in China and its principal debt consisted of New York law-governed notes. Moreover, the debtor was defending a $1.5 billion antitrust litigation in the Northern District of California brought by the Solyndra Residual Trust. Upon the debtor’s default on the notes, it agreed to restructure its debt through a scheme of arrangement in the Cayman Islands and a chapter 15 filing.

To maintain a chapter 15 case in New York, Suntech needed to establish both eligibility under the Bankruptcy Code and venue in the Southern District of New York. With less than a month to commence the chapter 15 case, however, it had neither business nor property in New York. As a result, the foreign administrators took steps, albeit unsuccessfully, given the expedited timeframe, to open a New York bank account at Morgan Stanley. Debtor’s counsel then requested the debtor’s claims agent to act as an escrow agent, and the debtor’s funds were subsequently transferred to a non-escrow account of the parent company of the claims agent.

After the chapter 15 petition was filed, Solyndra objected to recognition, arguing, among other things, that the foreign debtor was ineligible to be a chapter 15 debtor, that venue was improper in New York, and that the debtor’s COMI was not in the Cayman Islands. Central to the dispute were Solyndra’s allegations that Suntech engaged in bad-faith manipulation of the case by establishing the New York bank account on the eve of filing. The bankruptcy court rejected the allegations of manipulation and applied a flexible and easy-to-meet standard for eligibility and venue in finding Suntech eligible to be a debtor and venue proper in the Southern District of New York.

Suntech’s Eligibility to be a Debtor

Section 109(a) of the Bankruptcy Code sets forth the standard for debtor eligibility, which also applies to foreign debtors seeking chapter 15 relief, and provides, “only a person that resides or has a domicile, a place of business, or property in the United States . . . may be a debtor under” the Bankruptcy Code. The court, quoting another bankruptcy court decision, noted that the section is silent on the requisite amount of property and does not inquire into the acquisition of the debtor’s property to establish eligibility. The court rejected Solyndra’s contention that the foreign administrators opened the account on the eve of filing “to manipulate the placement of the case.” According to the court, “[i]nterpreting the Bankruptcy Code to prevent an ineligible foreign debtor from establishing eligibility to support needed chapter 15 relief will contravene the purposes of the statute to provide legal certainty, maximize value, protect creditors and other parties in interest[] and rescue financially troubled businesses.”

Contrary to Solyndra’s argument, the bankruptcy court held the basis for eligibility was ownership of the New York bank account and not the debtor’s purported conduct of business in California. Applying New York law and finding that title to the account was held by the claim agent’s parent as the debtor’s agent, the bankruptcy court concluded that the account was the debtor’s property.

Venue in New York

The bankruptcy court was likewise flexible on the venue question. As to the argument that the foreign administrators manipulated venue by establishing the New York account, the bankruptcy court noted that the foreign administrators had established the account “to solve the eligibility problem” and, by doing so, could not have wrested venue from California, “because the Debtor was ineligible to be a Debtor in the Northern District of California or anywhere else until it established the [New York] account.” The bankruptcy court applied section 1410 of title 28 of the United States Code, which provides a “hierarchy of choices” for venue in a chapter 15 proceeding and found, pursuant to the first subparagraph, that the account was the debtor’s principal asset in the United States at the time chapter 15 was filed.

A Spotlight on Eligibility and Venue

Suntech turns the spotlight on notable implications for bankruptcy professionals handling cross-border cases. In particular, the bankruptcy court’s interpretation of section 109(a) offers a more “open border” policy for foreign debtors to establish eligibility in the United States. Especially noteworthy is the court’s observation that the section does not provide a minimum amount for the property involved, nor does it require an investigation into how the debtor acquired the property. Once eligibility is established, foreign debtors seeking chapter 15 relief can then rely on their basis for eligibility to likewise establish venue in a particular district.

Although this decision took place in the context of a chapter 15 ancillary case, its implications are arguably much broader. Given that section 109(a) also governs eligibility to be a debtor under chapter 11, it may provide foreign corporations intending to commence a plenary proceeding in the United States a much easier path to do so. Others may argue that the court’s reasoning, which was based on policies underlying chapter 15, suggests that its less exacting application of section 109(a) should apply only in the context of chapter 15.

In tomorrow’s post, we will discuss the bankruptcy court’s COMI analysis and Solyndra’s argument that the foreign administrators had manipulated COMI in bad faith.

]]>A Comity of (Reversible) Error: Second Circuit Finds Foreign Debtor’s Claim Against U.S. Debtor Is “Located” in the United Stateshttps://business-finance-restructuring.weil.com/chapter-15/a-comity-of-reversible-error-second-circuit-finds-foreign-debtors-claim-against-u-s-debtor-is-located-in-the-united-states/
Thu, 16 Oct 2014 18:58:24 +0000http://business-finance-restructuring.weil.com/?p=11620Contributed by Alexander Woolverton The ability of a foreign debtor to avail itself of the protections of the Bankruptcy Code, such as the automatic stay, with respect to its property located within the United States is one of the most fundamental and valuable tools available to foreign debtors with domestically […]

The ability of a foreign debtor to avail itself of the protections of the Bankruptcy Code, such as the automatic stay, with respect to its property located within the United States is one of the most fundamental and valuable tools available to foreign debtors with domestically located property. When a foreign debtor obtains “recognition” of its principal insolvency proceeding by U.S. courts, section 1520 of the Bankruptcy Code does not only provide the foreign debtor the protections of the automatic stay, but also requires the foreign debtor to obtain approval under section 363 of the Bankruptcy Code with respect to any transfer of an interest in property within the territorial jurisdiction of the United States.

It is easier to say with certainty that certain types of property are “within the territorial jurisdiction of the United States” than other types. But what about a foreign debtor’s claim against a domestic debtor? About a year and a half ago, we blogged about a decision in which the United States Bankruptcy Court for the Southern District of New York ruled that a foreign debtor’s claim against a domestic debtor was not “located” in the United States. Since then, the decision was appealed to the United States District Court to the Southern District of New York, which agreed with the bankruptcy court.

Recently, the Second Circuit overruled both the bankruptcy and district courts and held that such a claim did indeed constitute “property within the territorial jurisdiction of the United States under section 1520(a)(2), and the transfer of such property was subject to a section 363 review by the bankruptcy court.

Background

As you might remember, Fairfield Sentry was one of the main “feeder funds” into Bernard L. Madoff Investment Securities (BLMIS). After BLMIS was placed into liquidation under the Securities Investor Protection Act, Sentry was placed into its own insolvency proceeding in the British Virgin Islands. Later, Sentry held an auction in which it sold its SIPA claim against BLMIS to Farnum Place, LLC for 32.125% of the claim’s allowed amount.

Shortly after the completion of the auction, Sentry and Farnum executed a trade confirmation that was expressly subject to the approval of both the BVI and U.S. courts. Shortly after that, the trustee of the BLMIS liquidation entered into a settlement that increased the value of the SIPA Claim from about 32% to more than 50% of the allowed amount, which translated into an increase in value of about $40 million. Sentry then did everything within its power to avoid being bound by the trade confirmation.

When Sentry refused to seek approval of the sale from the BVI court, Farnum sued to compel. Although the BVI court ruled in Farnum’s favor, it expressly declined to express any views on whether the bankruptcy court would – or should – approve the sale. Then, Sentry sought an order from the bankruptcy court, pursuant to section 363(b) of the Bankruptcy Code, denying approval of the sale.

The Bankruptcy Court Decision

The bankruptcy court denied Sentry’s motion, holding that its review of the sale was not governed by section 363 of the Bankruptcy Code, as Sentry contended, because it was not a transfer of property within the United States. Relying on a New York Court of Appeals decision, the bankruptcy court held that justice, convenience and common sense all led to the conclusion that the claim was located with Sentry in the BVI, not with BLMIS. Farnum appealed the bankruptcy court’s decision to the district court, lost, and appealed again to the Second Circuit.

The Second Circuit’s Decision

The Second Circuit began by characterizing the interest that Sentry had tentatively transferred to Farnum. Disagreeing with Sentry, the court reasoned that the property at issue was the SIPA Claim itself, not the funds in the BLMIS estate. The question, then, was the location of such an intangible interest. Section 1502(8) of the Bankruptcy Code defines “within the territorial jurisdiction of the United States” as (1) tangible property located in the United States, and (2) “intangible property deemed under applicable nonbankruptcy law to be located within that territory, including any property subject to attachment or garnishment that may properly be seized or garnished by an action in a Federal or State court in the United States.”

The Second Circuit, overruling the holding the SIPA Claim is “located” in the BVI, found fault with the bankruptcy court’s “incomplete” analysis – namely its failure to analyze whether the SIPA Claim was subject to attachment or garnishment within the meaning of section 1520.

Under New York law, property that can be assigned or transferred is subject to garnishment. With “respect to intangible property that has as its subject a legal obligation to perform, the situs is the location of the party of whom that performance is required pursuant to that obligation.” Because the BLMIS trustee “is obligated to distribute to Sentry its pro rata share of the recovered assets . . . the situs of the SIPA Claim is the location of the [BLMIS trustee], which is New York.” Accordingly, the Second Circuit concluded that because the sale of the SIPA claim constituted a transfer of property within the United States, the sale was subject to review under section 363 of the Bankruptcy Code by the bankruptcy court.

The Second Circuit further ruled that comity did not require approval of the sale. The court found that section 1520(a)(2)’s application of section 363 is a requirement that acts “as a brake or limitation on comity.” That is, notwithstanding principles of comity, a bankruptcy court must analyze a transfer of property within the United States pursuant to the standard applicable under section 363. Furthermore, the court noted that it was “not apparent at all that the BVI [c]ourt even expects or desires deference in this instance,” particularly because the BVI court specifically declined to express a view on whether the sale would be approved by the bankruptcy court. Accordingly, in light of the requirements of section 1520, the Second Circuit found that the bankruptcy court had erred in concluding that the SIPA claim was not “located” in the United States.

Conclusion: A Reverse and Remand With Helpful Dicta

The Second Circuit reversed the decisions below, ruling that the bankruptcy court would have to determine whether the sale of the SIPA Claim was permissible under section 363. While the Second Circuit “intimate[d] no view on the merits of the section 363 review on remand,” the court kindly provided “some guiding principles” for the bankruptcy court. Specifically, the Second Circuit noted bankruptcy courts often consider whether the asset is increasing or decreasing in value and that bankruptcy courts have broad discretion and flexibility to enhance the value of the estate for the benefit of all creditors. Last, the Second Circuit clarified that the bankruptcy court would be obligated to consider any fluctuation in value of the SIPA claim between the sale of the claim and approval by the bankruptcy court. Even though the Second Circuit did not rule on the sale, it seems Sentry’s chances of overturning it have dramatically improved.

]]>Brazilian Reorganization Plan: Fundamentally Fair or Wholesale Trampling of Creditors’ Rights?https://business-finance-restructuring.weil.com/chapter-15/brazilian-reorganization-plan-fundamentally-fair-or-wholesale-trampling-of-creditors-rights/
Thu, 09 Oct 2014 16:00:16 +0000http://business-finance-restructuring.weil.com/?p=11501Contributed by Sunny Singh The United States Bankruptcy Court for the Southern District of New York was recently presented in In re Rede Energia, S.A. with the question of whether a confirmed Brazilian reorganization plan for Rede Energia, S.A. should be enforced in the United States. Rede, one of the largest […]

The United States Bankruptcy Court for the Southern District of New York was recently presented in In re Rede Energia, S.A. with the question of whether a confirmed Brazilian reorganization plan for Rede Energia, S.A. should be enforced in the United States. Rede, one of the largest power companies in Brazil, filed a reorganization proceeding in Brazil after the operations of its regulated subsidiaries were seized. After an auction process for investments in Rede was completed, the Rede debtors proposed and confirmed a reorganization plan in accordance with Brazilian law. Thereafter, Rede’s foreign administrator commenced a chapter 15 proceeding in the United States and sought an order granting, among other things, full faith and credit to Rede’s confirmed Brazilian reorganization plan. An ad hoc group of noteholders—who rejected the plan in Brazil but were crammed down—objected to the U.S. bankruptcy court’s recognition of Rede’s plan, arguing that the plan and Rede’s Brazilian reorganization proceeding were a “wholesale trampling of their rights that was conceived of and executed by the Brazilian government and rubberstamped by the Brazilian bankruptcy court.” The New York bankruptcy court granted the relief requested over the ad hoc group’s objection.

Chapter 15 Rewind

A quick primer of chapter 15 may be helpful. Chapter 15 of the Bankruptcy Code provides a framework for recognizing and giving effect in the United States to foreign insolvency proceedings. It is premised on principles of comity. Generally, upon the commencement of a chapter 15 case and recognition as a foreign main proceeding, certain relief automatically goes into effect, as provided in section 1520 of the Bankruptcy Code. For example, the automatic stay immediately applies with respect to the property of the debtor that is within the territorial jurisdiction of the United States. In addition, sections 1507 and 1521 of the Bankruptcy Code authorize a bankruptcy court to provide “additional assistance” to a foreign representative or to grant “any appropriate relief” to effectuate the purpose of chapter 15. Recognition assistance of the types available under these sections is largely discretionary and turns on principles of comity. All relief available under chapter 15 of the Bankruptcy Code, however, is subject to the limitation in section 1506, which permits a court to decline to take any action that would be “manifestly contrary to the public policy of this country.”

Back to Brazil

As stated, after the regulatory seizure of its eight operating subsidiaries that distribute electricity to millions of customers throughout Brazil, Rede and certain of its subsidiaries (generally holding companies) filed for bankruptcy protection in Brazil. The regulated subsidiaries did not file. After the filing, Rede solicited offers of investment and received two competing bids. One of the bids providing for a substantial cash investment to be used to fund Rede’s regulated subsidiaries and also to pay the creditors of the Rede debtors was selected and incorporated into a reorganization plan.

The plan provided for three categories of unsecured creditors. One category was “Concessionarie Creditor Claims,” which were comprised of unsecured guaranty, surety or joint claims against Rede on account of a primary claim against a regulated subsidiary. A second category was the “Subsidiary Concessionaire Claims,” which were comprised of intercompany claims of the non-debtor regulated Rede affiliates. The third category included other general unsecured claims, primarily the claims of noteholders, including the ad hoc group, holding approximately $500 million in 11.125% perpetual notes issued by Rede. The plan provided that categories 1 and 2—the “Concessionaire Creditor Claims” and the “Subsidiary Concessionaire Claims”—would be paid in full. The noteholders, however, would receive a 25% cash payment on account of their claims. In addition, the Brazilian plan was premised on the substantive consolidation of assets and liabilities of the Rede debtors for voting and distribution purposes. The Brazilian court found that substantive consolidation was appropriate because the Rede group was “in fact organized as a corporate group, with a common controlling company and credit inter-dependence, as loans exist between the companies that comprise the group.”

The class of noteholder claims, which included the ad hoc group, did not accept the plan by the requisite majority. The plan was therefore confirmed by Brazilian bankruptcy court over the objection of the ad hoc group pursuant to the cram down provisions of Brazilian bankruptcy law (which are not the same as the cram-down provisions of U.S. bankruptcy law). When Rede’s administrator moved for recognition and enforcement of the plan in the U.S., the ad hoc group objected. The ad hoc group primarily relied on section 1506 and argued that enforcement of the Brazilian plan would be inconsistent with U.S. public policy because, among other things, similarly situated creditors were disparately treated and the substantive consolidation of the Rede debtors was improper.

The ad hoc group argued that substantive consolidation of the Rede debtors should not be recognized because a U.S. court would not have found that the standard for substantive consolidation in the Second Circuit—the familiar Augie/Restivo factors—was met. Although the facts in Rede Energia probably do not merit substantive consolidation under Augie/Restivo (and, in fact, seem to resemble typical operations of many corporations in the U.S.), the court overruled the objection. The bankruptcy court reasoned that chapter 15 does not require that the laws of Brazil be identical to the laws of the United States. Instead, it focuses on the process and whether creditors were given full access to information and a fair opportunity to be heard in the foreign proceeding. The court found that the record was clear that the ad hoc group was afforded due process and a full opportunity to object to the substantive consolidation before the Brazilian bankruptcy court, which the group exercised. The court, therefore, overruled the objection even though the Brazilian bankruptcy court did not consider factors that “ordinarily” would be considered by a U.S. court presented with substantive consolidation. The court stated that it would be inappropriate for a U.S. court to superimpose U.S. law on a case in Brazil. Not only would that be inefficient, but it would give creditors an unwarranted “second bite at the apple” by transforming a U.S. court into a foreign appellate court.

The ad hoc group also objected on the basis that similarly situated creditors were disparately treated under the Brazilian plan. Two classes of general unsecured creditors were being paid in full while the noteholders were only being paid 25% of their claims. Notwithstanding the differing treatment, the objection was overruled. As stated by the court, the issue presented was whether the treatment was wholly at odds with U.S. public policy, which the court found it was not. The court stated that the claims of the regulated affiliates and creditors with primary claims against the regulated entities had to be paid in full in order to lift the regulatory restrictions, thereby justifying the different treatment. The court cited U.S. chapter 11 cases where similarly situated creditors had been treated differently and even received drastically different recoveries when such treatment was justified.

Conclusion

The decision is a reminder that a U.S. court will not superimpose U.S. law or policy over a foreign administration. Creditors of foreign entities need to be prepared to play by the rules of the jurisdiction in which they chose to invest and should not count on a second bite at the apple in the U.S.

]]>Foreign Debtor Eligibility for Chapter 15: The Second Circuit’s Gateway Requirements May Not Limit Access After Allhttps://business-finance-restructuring.weil.com/chapter-15/foreign-debtor-eligibility-for-chapter-15-the-second-circuits-gateway-requirements-may-not-limit-access-after-all/
Tue, 01 Jul 2014 15:53:21 +0000http://business-finance-restructuring.weil.com/?p=10916On June 19, 2014, the Bankruptcy Court for the Southern District of New York once again granted Australia-based Octaviar Administration Pty Ltd. chapter 15 recognition as a foreign main proceeding, six months after the Second Circuit overturned an earlier order granting the same relief. The bankruptcy court overruled objections to […]

]]>On June 19, 2014, the Bankruptcy Court for the Southern District of New York once again granted Australia-based Octaviar Administration Pty Ltd. chapter 15 recognition as a foreign main proceeding, six months after the Second Circuit overturned an earlier order granting the same relief. The bankruptcy court overruled objections to the petition for recognition from Drawbridge Special Opportunities Fund LP, a defendant in litigation that the Octaviar court-appointed liquidators are pursuing in the U.S., finding that Octaviar has property in the U.S. to satisfy the eligibility requirements of section 109(a) of the Bankruptcy Code, as required by the Second Circuit for granting chapter 15 relief. The decision may indicate that the gateway requirements imposed by the Second Circuit are not such an impediment to foreign debtors seeking chapter 15 relief.

Background

Octaviar’s directors placed Octaviar into voluntary administration in Australia in October 2008; the Supreme Court of Queensland, Australia, appointed Katherine Elizabeth Barnet and William John Fletcher as liquidators of Octaviar in July 2009. Octaviar first filed its chapter 15 petition seeking recognition of the Australian proceeding in August 2012.

Drawbridge, which was already a defendant in litigation the court-appointed liquidators had commenced in Australia, objected to Octaviar’s chapter 15 petition on the basis that (i) Octaviar did not have a domicile, place of business or property in the U.S., as required by section 109(a), and (ii) that chapter 15 could not be used solely for discovery in aid of a litigation pending in a foreign proceeding. In initially granting chapter 15 recognition in September 2012, the bankruptcy court held that there was no requirement that an entity that is the subject of a foreign proceeding be domiciled or have a residence, place of business, or property in the United States in order for the foreign proceeding to be recognized under chapter 15. However, at the request of the liquidators and Drawbridge, the bankruptcy court certified its recognition order for direct appeal to the U.S. Court of Appeals for the Second Circuit to consider, among other things, whether the debtor eligibility requirements of Bankruptcy Code section 109(a) applied to petitions for recognition of a foreign main proceeding under chapter 15 of the Bankruptcy Code.

The Second Circuit vacated the bankruptcy court’s decision in December 2013, unanimously holding for the first time that bankruptcy courts may not grant recognition to a foreign insolvency proceeding under chapter 15 unless the debtor that is the subject of the foreign proceeding has a domicile, residence, business or property in the U.S., as required by section 109(a).

After the Second Circuit issued its decision, Octaviar’s liquidators filed a second chapter 15 petition in February 2014 and renewed their request for recognition of the Australian proceeding as a foreign main proceeding, this time asserting that Octaviar had property in the U.S. in the form of claims and causes of action against Drawbridge and other U.S. entities and an undrawn retainer with U.S. counsel. The bankruptcy court once again found that the Australian proceeding qualified for recognition as a foreign main proceeding because (i) the causes of action, although related to other causes of action proceeding in Australia, were located in the U.S. and (ii) the foreign representatives had not manufactured eligibility by transferring the funds to their U.S. attorneys.

The Intangible Property Was Sufficient

The bankruptcy court noted that, even in their first chapter 15 petition, the liquidators made clear that, in furtherance of their primary goal of marshaling Octaviar’s assets and making distributions to creditors, they were seeking chapter 15 recognition to investigate potential causes of action against entities in the U.S. and to prosecute those claims in the U.S. In their second chapter 15 petition, the liquidators more clearly identified those causes of action, and had actually commenced litigation against Drawbridge and other related entities in both the District Court for the Southern District of New York and in the New York Supreme Court. Thus, the liquidators met their burden of demonstrating that Octaviar had property in the U.S. to satisfy the eligibility requirements of section 109(a).

In determining that the causes of action were located in the U.S. rather than Australia, where Octaviar was domiciled, the court found that the liquidators’ claims were brought under U.S. law and involved defendants located in the U.S. (that were different from those in related actions pending in Australia) and allegations that funds were wrongfully transferred to the U.S. The U.S. courts had both subject matter and personal jurisdiction, and so the bankruptcy court concluded the claims were present in the U.S.

The Undrawn Retainer

The bankruptcy court also found that the $100,000 that the liquidators had transferred to their U.S. counsel prior to the filing of the second chapter 15 petition was sufficient to meet the requirements of section 109(a). Drawbridge did not dispute that the funds were property in the U.S. that existed by the time the liquidators renewed their request for recognition, but instead argued that the transfer of funds was a bad faith attempt to manufacture chapter 15 eligibility and to evade the consequences of the Second Circuit’s ruling.

The bankruptcy court found that the liquidators acted in good faith in transferring the funds to their counsel’s client trust account. The court noted that retainers can serve as a basis for section 109(a) compliance, and serve an “obvious legitimate economic function, understood by every practicing attorney.” In addition, the court noted that section 109(a) is silent regarding the amount of such property in the U.S. and does not require an inquiry into the circumstances surrounding the debtor’s acquisition of such property. Therefore, the court reasoned that to impose a requirement that the property in the U.S. be “substantial” would circumvent the plain meaning of the statute, which the Second Circuit had characterized as straightforward when it considered the eligibility issues on appeal.

Policy Implications

In granting recognition the second time around, the bankruptcy court emphasized that the relief was consistent with the goals of chapter 15 (promoting cooperation among courts), and that denial of recognition would deprive the liquidators of the opportunity to bring causes of action on behalf of Octaviar in the United States. The court also noted that Drawbridge was not without recourse – its arguments were akin to a forum non conveniens defense, and it could bring such a motion, provided that it consented to jurisdiction in Australia (which Drawbridge apparently was not subject to and did not at that point consent to), or it could seek to stay the federal and state court proceedings as duplicative or derivative of the Australian litigation. In this respect, the bankruptcy court did not see its order granting chapter 15 recognition to Octaviar’s Australian proceeding as prejudicing Drawbridge or abridging its rights to assert all available defenses in the federal and state court actions.

Conclusion

Many commentators have expressed concern that the new requirements for chapter 15 recognition imposed by the Second Circuit in the 2013 decision would create a material obstacle to chapter 15 relief for foreign debtors and drive foreign debtors to seek recognition in courts outside the Second Circuit. The decision on remand in Octaviar, however, shows that courts in the Southern District of New York, at least, still view themselves as having considerable flexibility in interpreting the eligibility requirements for foreign debtors to avail themselves of the benefits of recognition under chapter 15. It remains to be seen whether Drawbridge will appeal again, but we will follow this interesting case and update our readers if there are any significant developments.

]]>Chapter 15 Recognition of a Foreign Main Proceeding: Balancing Parties’ Interestshttps://business-finance-restructuring.weil.com/chapter-15/chapter-15-recognition-of-a-foreign-main-proceeding-balancing-parties-interests/
Wed, 07 May 2014 18:08:19 +0000http://business-finance-restructuring.weil.com/?p=10552Chapter 15 recognition of a foreign main proceeding can be a useful tool for a foreign debtor seeking to protect property in the United States. The protections of chapter 15, however, are subject to the bankruptcy court’s discretion and guided by a host of potentially conflicting policy considerations. Chapter 15 […]

]]>Chapter 15 recognition of a foreign main proceeding can be a useful tool for a foreign debtor seeking to protect property in the United States. The protections of chapter 15, however, are subject to the bankruptcy court’s discretion and guided by a host of potentially conflicting policy considerations. Chapter 15 is designed to promote, among other things, the “fair and efficient administration of cross-border insolvencies that protects the interests of all creditors, and other interested entities, including the debtor.” This means that the court in chapter 15 must balance parties’ competing interests to a greater degree than in cases under other chapters of the Bankruptcy Code.

A directive to balance parties’ interests generally does not lend itself to commercial certainty, and so judicial decisions explaining how courts balance parties’ interests tend to be welcome developments in chapter 15 law. In a recent decision in the chapter 15 case In re Cozumel Caribe, S.A. de C.V., the United States Bankruptcy Court for the Southern District of New York established principles for balancing parties’ interests when a U.S. creditor alleges misconduct by the foreign representative.

Cozumel Caribe and CT Investment Management

Cozumel Caribe is a Mexican company that owns and operates the Hotel Park Royal Cozumel, an all-inclusive resort in Cozumel, Mexico. It is reorganizing in a concurso mercantile proceeding in Mexico. In 2010, Cozumel Caribe commenced a chapter 15 case in the Southern District of New York and obtained recognition of its concurso proceeding as a foreign main proceeding.

Cozumel Caribe’s reorganization has involved significant litigation over a claim and other rights asserted by CT Investment Management, the special servicer of securitized notes backed by $103 million in secured loans made to Cozumel Caribe. CTIM holds $8 million in cash in the U.S. as security for those loans and has been seeking to exercise remedies against that cash. It has not only asserted a $103 million claim against Cozumel Caribe’s concurso estate, but also commenced an action in the United States against Cozumel Caribe’s non-debtor affiliates and certain non-debtor guarantors of the secured loans. So far, CTIM’s efforts have been unsuccessful.

CTIM’s Motion to Terminate Recognition of the Foreign Main Proceeding

CTIM moved to terminate the recognition of Cozumel Caribe’s foreign main proceeding on the basis that continued recognition of the proceeding “would be manifestly contrary to U.S. public policy.” CTIM asserted that, among other things,

the foreign representative took inconsistent positions in the concurso proceeding and the chapter 15 case “on the key issue of the amount of CTIM’s claim”;

the foreign representative used the recognition order to block enforcement of a non-debtor guarantee in a U.S. district court, and then Cozumel Caribe sought to invalidate that guarantee by obtaining a default judgment in a Mexican court;

Cozumel Caribe attempted to transfer assets out of the concurso estate for no consideration; and

the foreign representative failed to inform the U.S. bankruptcy court of material developments in the concurso proceeding.

These and other actions, CTIM contended, were so contrary to U.S. public policy that they justified terminating the bankruptcy court’s recognition of the concurso proceeding.

The Bankruptcy Court Denied CTIM’s Motion

The bankruptcy court denied CTIM’s motion primarily because “any decisions made in the Concurso Proceeding may be subject to further proceedings in the Mexican courts.” The court explained the problem as follows:

CTIM is not entitled to relief in this Court [just] because it feels slighted by decisions or actions in Mexican court proceedings — proceedings that remain open and ongoing, with multiple parties pursuing ancillary or appellate relief. Dissatisfaction with rulings of the lower Mexican courts is the proper subject for Mexican appellate proceedings, but does not implicate the Recognition Order.

For CTIM, however, good things may indeed come to those who wait. The court explained that, although it was upholding recognition of the foreign main proceeding, Cozumel Caribe would still need to obtain the court’s recognition of orders entered in that proceeding to gain any substantive relief in the U.S. “Granting comity to orders of a foreign court is not an all or nothing exercise,” the court reasoned. “[S]ome orders or judgments in the same case or proceeding may merit comity while others may not.”

As for the foreign representative’s taking inconsistent positions in the concurso proceeding and the chapter 15 case, the bankruptcy court held that sanctions — which CTIM was not seeking — were the appropriate remedy. Such conduct did not implicate the recognition of the foreign main proceeding.

Finally, the bankruptcy court ordered the foreign representative to file status reports of all material developments in the concurso proceeding at least every three months. CTIM has an opportunity to file responses to each of those reports.

Cozumel Caribe illustrates one way that a bankruptcy court in chapter 15 may attempt to “protect[ ] the interests of all creditors, and other interested entities, including the debtor” by balancing those interests:

Although potentially unfair results in foreign lower-court proceedings do not justify terminating recognition of the foreign main proceeding, the U.S. bankruptcy court need not recognize the substantive orders entered in the foreign main proceeding unless those orders comport with U.S. public policy.

Although the foreign representative’s failure to comply with his chapter 15 disclosure obligations to the U.S. bankruptcy court do not justify terminating recognition of the foreign main proceeding, a stricter reporting requirement in the chapter 15 case is an appropriate remedy.

Although the foreign representative’s taking inconsistent positions in the concurso proceeding and the chapter 15 case did not justify terminating recognition of the foreign main proceeding, sanctions in the chapter 15 case may be an appropriate remedy.

Implications for Parties in Chapter 15 Cases

Cozumel Caribe suggests that foreign representatives face a relatively low bar to obtaining and maintaining recognition of a foreign main proceeding. But by the same token, recognition of the proceeding may be of limited use to a foreign debtor seeking to enforce that proceeding’s outcomes in the U.S. unless those outcomes generally comport with U.S. public policy.

For U.S. creditors of foreign debtors, Cozumel Caribe may provide a basis to challenge the U.S. validity of every final order entered in the foreign proceeding on public policy grounds. Finality, though, may be the key: A creditor that perceives a foreign proceeding as unfair may need to wait for some measure of finality in that proceeding before it can seek relief in chapter 15. This could be viewed as similar to the general prohibition on interlocutory appeals in the U.S. judicial system.

Finally, for foreign debtors making use of chapter 15, Cozumel Caribe serves as an admonishment to make the foreign proceeding’s process and substantive results consistent with U.S. public policy. Foreign debtors that ignore U.S. public policy in their foreign proceedings risk becoming unable to enforce that proceeding’s outcomes in the U.S.

]]>Foreign Bitcoin Exchanges and Chapter 15https://business-finance-restructuring.weil.com/chapter-15/bitcoin-bankruptcy-foreign-bitcoin-exchanges-and-chapter-15/
Tue, 11 Mar 2014 17:06:48 +0000http://business-finance-restructuring.weil.com/?p=10130The Japanese insolvency and chapter 15 bankruptcy filing of bitcoin exchange Mt.Gox raise a host of questions about parties’ rights to bitcoins—assets that defy neat analysis under existing legal frameworks. How would a bitcoin exchange be restructured or liquidated? What assets does it have, and where are they situated? And […]

]]>The Japanese insolvency and chapter 15 bankruptcy filing of bitcoin exchange Mt.Gox raise a host of questions about parties’ rights to bitcoins—assets that defy neat analysis under existing legal frameworks. How would a bitcoin exchange be restructured or liquidated? What assets does it have, and where are they situated? And what are those assets in the first place?

Bitcoin Bankruptcy

The Weil Bankruptcy Blog is pleased to announce a new series titled “Bitcoin Bankruptcy.” We will explore the legal questions that a hypothetical bankruptcy of a bitcoin exchange might pose under the Bankruptcy Code. We will also consider the implications of such a bankruptcy on the debtor exchange, its customers, its creditors, the bitcoin market and its infrastructure, and regulatory authorities. Today, we provide some background on Bitcoin and consider some of the questions raised by Mt. Gox’s chapter 15 filing.

What Is Bitcoin and How Does It Work?

Bitcoin is a digital payment system that functions as money among those who attribute value to it. To finance professionals, Bitcoin is a hybrid form of asset that straddles the line between currency and commodity. For example, the following are some of Bitcoin’s currency-like properties:

Bitcoin is a medium of exchange used to purchase goods and services.

Bitcoin has exchange rates against government-sponsored currencies.

Bitcoins can be taken offline and converted to tangible form.

A searchable record of all Bitcoin transactions (called the “block chain”) is maintained.

Bitcoins appear to have no nonmonetary value (unlike things like oil, wheat, or gold).

Yet Bitcoin also has the following commodity-like properties:

Bitcoin is not backed by a government and has no centralized regulatory authority.

Bitcoins are scarce: a maximum of only 21 million bitcoins will ever exist.

Bitcoins are released into circulation gradually (through a process known as “mining”).

Bitcoin prices are extremely volatile and may not be susceptible to stabilization by a government.

At a high level, transacting in Bitcoin is similar to transacting in any other currency. A prospective Bitcoin market participant opens an account with a Bitcoin “wallet” service—an Internet company that holds one’s bitcoins in what is essentially a deposit account. The participant visits a Bitcoin exchange, which works like any other type of currency exchange, selling bitcoins for other currencies at various exchange rates that fluctuate over time. The exchange matches a buyer with a seller and earns the bid-ask spread on the transaction. The participant pays for the Bitcoins using PayPal, wire transfer, or another payment system and deposits those bitcoins in his or her wallet.

The market participant might be a consumer. A consumer can spend his or her bitcoins wherever bitcoins are accepted, such as the websites for Overstock.com or the Sacramento Kings basketball team. But the market participant might instead be an investor. An investor might buy bitcoins at one price and sell them at a higher price; use them to hedge transactions in other currencies; or use them for other types of financial transactions.

Bitcoins can also be converted from digital form into physical form. Market participants can perform these conversions at bitcoin ATMs and store physical bitcoins in wallets. A number of market participants have in fact converted their bitcoins into physical form and stored them in safe-deposit boxes at banks.

Most governments and companies do not presently accept Bitcoin as a medium of exchange, but Bitcoin’s acceptance has been growing in most parts of the world since Bitcoin’s introduction in 2009. Bitcoin prices are extremely volatile, though. Bitcoins traded around $5 in March 2012; over $1,200 in November 2013; and between $600 and $700 on most major exchanges over the past week.

Transaction Mechanics and Market Infrastructure

At a more granular level, Bitcoin’s transaction mechanics differ markedly from other forms of payment. These differences may raise significant questions regarding how bitcoin-based transactions should be analyzed under the Bankruptcy Code and other restructuring frameworks.

For a frame of reference, suppose a buyer purchases goods from a seller via PayPal. PayPal serves as a third party escrow-type agent that both parties trust will clear the transaction properly. As an intermediary, PayPal is also a means by which a buyer can initiate a chargeback—i.e., reverse the transmission of funds where the buyer disputes the transaction. For most purposes, this is a typical online payment structure.

Bitcoin transactions are fundamentally different. A Bitcoin transaction occurs between a buyer and a seller, each of which is identified only by a unique publicly available code called an “address.” The transaction occurs on a peer-to-peer basis, and that is Bitcoin’s most significant innovation: it does not require a bank or other trusted third party to clear transactions. Instead, Bitcoin relies on what one might call “crowdsourced market infrastructure.”

When a Bitcoin transaction takes place, a signal announcing the transaction is sent out to the Bitcoin market. The signal is received by thousands of computers with specialized hardware called “miners.” Miners perform calculations (called “mining”) that verify that the transaction they have received is, in fact, a valid transaction involving unique bitcoins. When a critical percentage of miners have verified the transaction, the transaction is considered valid and is recorded in the block chain, a public ledger. No third party clears transactions, and so transaction costs are generally low. Chargebacks are difficult or impossible for buyers to perform.

A word about miners: Miners’ incentive to verify transactions is that they receive bitcoins for doing so. The more effective a miner is at mining, the more bitcoins it receives. The bitcoins are distributed to miners by the Bitcoin network, and mining gets more difficult as more bitcoins are mined. The Bitcoin network will stop distributing bitcoins once 21 million bitcoins have been distributed.

This is just an overview of Bitcoin, but much more writing is available online for those interested in more detail.

The Mt. Gox Crisis

Mt. Gox is a bitcoin exchange headquartered in Tokyo, Japan. It was once the world’s largest bitcoin exchange. Mt. Gox operated two related businesses—an exchange and a wallet system—for both its own accounts and its customers’ accounts. It managed both hot wallets and cold wallets. A “hot” wallet is a bitcoin wallet that is maintained on a computer connected to the Internet. A “cold” wallet is maintained on an offline computer.

Mt. Gox has asserted that, in early February 2014, unidentified hackers may have broken into its wallet system—apparently both hot and cold, and both its own accounts and its customers’ accounts—and stolen approximately 850,000 bitcoins. Following its discovery of the bitcoin losses, Mt. Gox stopped permitting customers to make withdrawals from their wallets. On February 28, 2014, Mt. Gox commenced a bankruptcy-like civil rehabilitation proceeding in Tokyo. Yesterday, Mt. Gox petitioned the United States Bankruptcy Court for the Northern District of Texas for chapter 15 relief.

Chapter 15 for a Non-U.S. Bitcoin Exchange

Generally, a debtor’s decision whether to file under chapter 15 is a strategic or practical one. Chapter 15 facilitates the debtor’s foreign proceeding (i.e., its proceeding outside of the United States) by granting judicial recognition of that proceeding in the United States. A debtor in a foreign proceeding can use chapter 15 to protect assets situated in the United States; to establish U.S. procedures for filing claims in the foreign proceeding; to facilitate asset sales approved in the foreign proceeding; and for certain other purposes. In its case, Mt. Gox asserts that it has sought chapter 15 relief to avoid “expend[ing] substantial monetary and personnel resources” to defend itself in litigation pending in the United States.

Mt. Gox may be the next debtor to raise the question whether section 109(a) of the Bankruptcy Code applies to debtors seeking chapter 15 relief. Section 109(a) requires, among other things, that a debtor in a bankruptcy case have “a domicile, a place of business, or property in the United States.” The United States Court of Appeals for the Second Circuit recently held that section 109(a) applies to debtors in foreign proceedings seeking relief under chapter 15. By contrast, the United States Bankruptcy Court for the District of Delaware recently held in an oral ruling that section 109(a) does not apply to a debtor in a foreign proceeding. In Mt. Gox’s case, no one seems to know what, if any, property Mt. Gox has in the United States. And for that matter, it is unclear what kind of property a foreign-based bitcoin exchange would be expected to have in the United States.

Where in the World Is Property of the Estate? (And What Is That Property?)

In general, the kinds of property a foreign bitcoin exchange could have in the United States might include a website, servers, data, bitcoins, and other intellectual property, among other things. Yet there may not be clear answers on where certain of these intangible assets are situated. For example: where is data situated? Is it on a physical server; in the owner’s principal place of business; in the owner’s jurisdiction of incorporation; or somewhere else? Does it depend on what kind of data is at issue? Do bitcoins in digital form constitute data or some other kind of property?

Further, it is unclear whether customers’ bitcoins constitute property of the debtor’s estate or custodial property held in trust for the debtor’s customers. (In other words, do customers constitute creditors?) In the context of a typical (fiat) currency, a deposit of funds into a bank account generally creates a debtor-creditor relationship between the bank and the depositor. Yet it is unclear whether the same would be true for the deposit of a bitcoin into a wallet. The commodity-like property of bitcoins may weigh in favor of considering the bitcoin-wallet relationship one of custody rather than of debt.

Notice and Service Procedures May Be Antiquated.

Bitcoin exchange bankruptcies also raise the question whether currently applicable service and notice procedures are obsolete. For example, when a typical debtor commences a bankruptcy case, it generally provides notice of the case to known creditors by mail and to unknown creditors by newspaper publication. But these methods may not work for a bitcoin exchange. Parties transacting in bitcoin are identifiable only by their public pseudonyms, and they may be located anywhere in the world. Their mailing addresses likely are all unknown, and there may be no way to determine which newspaper would most effectively reach creditors. Thus, traditional methods of giving notice—and, for similar reasons, of serving process—may not apply in the bankruptcy of a bitcoin exchange. It may be that the bitcoin exchange’s website itself constitutes the most effective forum for providing notice and serving process in the case. Moreover, the involvement in bitcoin exchanges by parties located all over the world may implicate novel questions of the statutory and constitutional reach of bankruptcy courts’ in personam jurisdiction.

More to Come

These issues are just the tip of the Bitcoin Bankruptcy iceberg. In future posts, we will explore the issues that may arise in a hypothetical bankruptcy of a U.S.‑based bitcoin exchange. We are excited to discuss what may be the next new frontier of restructuring law.

]]>Post-Vitro, SDNY Bankruptcy Court Approves Recognition Order Seeking Enforcement of Third Party Releaseshttps://business-finance-restructuring.weil.com/chapter-15/post-vitro-sdny-bankruptcy-court-approves-recognition-order-seeking-enforcement-of-third-party-releases/
Wed, 11 Dec 2013 18:01:19 +0000http://business-finance-restructuring.weil.com/?p=9728Contributed by Andrea Saavedra In a previous blog post, we examined the Fifth Circuit Court of Appeals’ Vitro decision, in which it upheld the bankruptcy court’s denial of a request by a foreign debtor’s representative for recognition and enforcement of a Mexican plan of reorganization that contained non-consensual third party […]

In a previous blog post, we examined the Fifth Circuit Court of Appeals’ Vitro decision, in which it upheld the bankruptcy court’s denial of a request by a foreign debtor’s representative for recognition and enforcement of a Mexican plan of reorganization that contained non-consensual third party releases. Among other things, the Vitro releases were deemed unenforceable because, if upheld, they would have eviscerated certain creditors’ collection rights under separate guaranties issued by Vitro’s U.S. non-debtor affiliates. In its decision, the Fifth Circuit established a three-step process for courts to apply when faced with the question of granting comity to the orders of a foreign court once a foreign proceeding has been recognized: first, determine whether relief would be available under section 1521(a) or (b) of the Bankruptcy Code; second, if the requested relief is not specifically available thereunder, decide whether the relief can be considered “appropriate relief” under section 1521(a); and, lastly, if the relief is not “appropriate relief,” determine whether the requested relief may be granted under section 1507 of the Bankruptcy Code (which permits the U.S. court to grant such “additional assistance” as is consistent with the principles of comity). In our entry, we queried whether other courts would follow suit and apply the Fifth Circuit’s three-step process.

Well, ask and you shall receive!

Recently, in the chapter 15 case of In re Sino-Forest Corp., Judge Glenn of the Bankruptcy Court for the Southern District of New York was faced with a foreign debtor representative’s request for recognition and enforcement of certain orders entered in the Canadian debtor’s bankruptcy case. Specifically, as part of its plan of compromise and reorganization, the debtor and its co-defendants agreed to settle certain securities-related class action cases that were pending in both the U.S. and Canada. As part of the settlement, the debtor’s auditor agreed that, upon satisfaction of certain conditions precedent (including, among other things, recognition and enforcement of the terms of the settlement in the U.S.), it would pay $117 million into a settlement trust fund to be distributed to class members under the plan. In return for such payment (and other non-monetary consideration), the auditor was to receive a global release and the benefit of certain injunctions under the plan. While a small minority of creditors objected to the terms of the settlement and the plan, the majority of stakeholders were supportive, and the settlement and plan were approved by the Ontario court overseeing the debtor’s arrangement.

In granting recognition and enforcement of the settlement order and the debtor’s plan, Judge Glenn noted that the court could grant the requested relief under the “additional assistance” provisions of section 1507. In so doing, he reasoned that the question was not whether he should approve, in the first instance, the grant of broad third party releases (which he observed are available in “rare” circumstances in the Second Circuit, in contrast to their outright prohibition in the Fifth Circuit), but rather whether the “foreign orders should be entered” in a chapter 15 case. Because the issue of the propriety of the third party releases had been “fully and fairly” litigated in the Canadian courts, the bankruptcy court found that it could recognize and enforce the releases in the United States under the comity considerations set forth in section 1507. Because section 1507 provided the court with adequate grounds under which to recognize and enforce the Ontario court’s orders after recognition of the Canadian proceeding, the bankruptcy court did not need to reach the question as to whether such third party releases could be recognized under section 1521 in accordance with the three-step analysis offered by the Fifth Circuit.

Further, the bankruptcy court noted that granting the requested relief was firmly outside the provisions of section 1506 of the Bankruptcy Code, which otherwise would permit it to refuse to “take an action” that would be “manifestly contrary to the public policy of the United States.” Although the federal circuits are split on the issue of the availability of non-consensual third party releases, Judge Glenn noted that the existence of the split itself demonstrated that third party releases are not “manifestly contrary” to public policy. He also observed that the Vitro decision did not dictate a different result as the Fifth Circuit specifically declined to reach the application of section 1506, if any, in that case.

The Sino-Forest decision demonstrates that Vitro does not necessarily stand for the per se prohibition against recognition of foreign restructuring plans that grant non-consensual third party releases. Indeed, so long as granting such relief is not inconsistent with general principles of comity and, among other things, the validity of such releases was fully and fairly litigated in the foreign proceeding, a bankruptcy court may be willing to enforce them in the United States.

Fully recharged after last week’s Thanksgiving respite, the United States Court of Appeals for the Fourth Circuit this week affirmed a 2011 bankruptcy court decision denying a chapter 15 debtor’s attempts to terminate, under foreign insolvency law, various U.S. patent licensing agreements. We previously discussed the decision by the United States Bankruptcy Court for the Eastern District of Virginia here.

The decisions in In re Qimonda deal with the ability of a foreign debtor, through its foreign representative in a chapter 15 case, to terminate unilaterally U.S. patent licensing agreements, pursuant to foreign law (in this case, section 103 of the German Insolvency Code). In Qimonda, the chapter 15 debtor’s foreign representative attempted to terminate licenses of U.S. patents that the debtor had granted to a large number of technology companies. The licensees objected and argued that the foreign administrator should be bound by the licensee protections included in section 365(n) of the Bankruptcy Code. The foreign representative argued that, under the German insolvency regime, he was permitted to terminate a debtor’s license agreements, leaving licensees without the benefit of their prepetition agreements. In contrast, under U.S. bankruptcy laws, the normally broad rejection power granted a trustee or debtor in possession by section 365(a) is limited with respect to certain intellectual property licenses, including U.S. patent licenses, as a result of section 365(n). Specifically, section 365(n) permits a patent licensee to elect to retain certain rights under its prepetition license despite a debtor’s decision to reject that license.

The foreign representative in Qimonda argued that German laws should apply to the termination of the licenses, while the licensees argued that section 365(n) should apply. Ultimately, the applicability of section 365(n) hinged on the court’s examination of sections 1506, 1521, and 1522 of the Bankruptcy Code. Section 1521(a)(7) permits a court, in the exercise of its discretion, to grant a chapter 15 foreign representative “additional relief” above and beyond the limited provisions made applicable by way of sections 1520 and 1521(a)(1)-(6) of the Bankruptcy Code. Section 1522, however, tempers the broad grant of authority provided in section 1521 by providing that a bankruptcy court may only grant relief under section 1521 if “the interests of the creditors and other interested entities, including the debtor, are sufficiently protected.” Section 1506 of the Bankruptcy Code further permits a court to refuse to take any action to the extent that doing so would be “manifestly contrary to the public policy of the United States.”

After a four-day evidentiary hearing, the bankruptcy court in Qimonda held that the balancing of debtor and creditor interests mandated by a joint reading of sections 1521(a)(7) and 1522 of the Bankruptcy Code favored the application of section 365(n) with respect to the U.S. patent portfolio of Qimonda. The bankruptcy court also found that permitting a debtor to terminate U.S. patent licensing agreements non-consensually pursuant to foreign law would be “manifestly contrary to the public policy of the United States” and would, therefore, implicate section 1506 of the Bankruptcy Code. The Fourth Circuit, on direct appeal from the bankruptcy court, affirmed the bankruptcy court’s ruling on the first basis and, as a result, did not directly reach the issue of whether the public policy exception provided in section 1506 of the Bankruptcy Code applied to the non-consensual termination of patent licensing agreements.

Qimonda’s foreign representative raised three arguments on appeal, all of which were rejected by the Fourth Circuit. First, the representative argued that because he had not specifically requested the inclusion of section 365(n) among his “additional” 1521 powers at the outset of the case, the court was not required to undertake a section 1522 balancing analysis with respect to that section. In other words, because the foreign administrator did not explicitly seek inclusion of section 365 in the court’s 1521 order, his authority to assume or reject should be governed by foreign law. The Fourth Circuit found that although the administrator had not specifically requested the powers afforded by section 365 of the Bankruptcy Code, he had requested, pursuant to other provisions of section 1521, that the bankruptcy court entrust him broadly with the “administration or realization of all or part of the assets of [Qimonda] within the territorial jurisdiction of the United States” and had specifically included the debtor’s U.S. patent portfolio among the enumerated assets that he sought to control. Accordingly, the court held that as a prerequisite to granting any relief under section 1521 of the Bankruptcy Code, it was required to ensure sufficient protection of all interested parties pursuant to section 1522 and was entitled to subject such section 1521 relief to whatever conditions the court deemed appropriate, including the incorporation of licensee protections provided under U.S. bankruptcy laws.

Second, the foreign representative argued that the bankruptcy court misinterpreted the requirements of section 1522 of the Bankruptcy Code and that the bankruptcy court was not required to undertake a “balancing” analysis – weighing the interests of the creditors against those of the chapter 15 debtor. Specifically, the representative argued that section 1522 merely serves as a procedural protection designed to ensure that all creditors are able to participate in the bankruptcy case on an “equal footing.” According to the representative, the design of chapter 15 mandates that courts defer to foreign law except to the extent that those laws implicate section 1506 of the Bankruptcy Code and are “manifestly contrary to the public policy of the United States.” In rejecting this argument, the Fourth Circuit focused on the language of the Model Law on Cross-Border Insolvency and its accompanying Guide to Enactment – specifically Article 22 of the Model Law, on which section 1522 of the Bankruptcy Code is based. The Model Law’s Guide to Enactment specifically contemplated the need for courts to balance between the relief sought by a foreign representative and the interests of the persons affected by such relief, in particular local creditors. In light of the language of chapter 15 and the Guide to Enactment, the Fourth Circuit found that the bankruptcy court had correctly applied a balancing analysis and that section 1506 merely provided an “additional, more general protection of U.S. interests that may be evaluated apart from the particularized analysis” of section 1522 of the Bankruptcy Code.

Finally, the foreign representative argued that even if a balancing analysis under section 1522 were appropriate, the bankruptcy court’s analysis was flawed because it overstated the potential harm to the licensees. The Fourth Circuit was, however, persuaded by the bankruptcy court’s comprehensive analysis and found that the bankruptcy court had exercised reasonable discretion in concluding that although application of section 365(n) would invariably reduce the value of the debtor’s U.S. patent portfolio, it would not render it worthless. The debtor could, for example, continue entering into license agreements with new counterparties. The licensees, however, stood to lose very substantial research and development investments made in reliance on the licensing agreements. The Fourth Circuit, like the bankruptcy court, expressed serious concern that permitting a foreign debtor to terminate intellectual property licenses would inject a “dangerous degree of uncertainty into a licensing system that plays a critically important role in the semiconductor industry, as well as other high-tech sectors of the global economy.” Additionally, as noted in the bankruptcy court’s decision, granting the relief requested by the representative would undermine one of Congress’ primary purposes in enacting section 365(n) – to encourage developers to accept property licenses instead of outright assignments, thereby increasing returns to inventors and creating incentives for research and development.

The decision highlights the interesting tension between the United States’ interests in protecting U.S. creditors and its interest in cooperating with foreign insolvency proceedings. The decision is a major victory for U.S. patent licensees, but it remains to be seen how other courts will apply the Fourth’s Circuit’s “balancing test” under different circumstances. At this time, the foreign representative has not yet sought leave to appeal or to have the issue reheard en banc, but we will continue to monitor the docket and provide any updates going forward.

Weil represents Micron Technology, Inc., one of the licensees of Qimonda AG’s patents discussed in this blog post.

]]>Cutting in Line Will Not Be Tolerated: Third Circuit Grants Recognition to Australian Bankruptcy Proceedings and Prevents Unsecured Creditor From Seizing U.S. Assetshttps://business-finance-restructuring.weil.com/chapter-15/cutting-in-line-will-not-be-tolerated-third-circuit-grants-recognition-to-australian-bankruptcy-proceedings-and-prevents-unsecured-creditor-from-seizing-u-s-assets/
Thu, 19 Sep 2013 19:51:48 +0000http://business-finance-restructuring.weil.com/?p=9354Contributed by Katherine Doorley Should a foreign restructuring process that allows secured creditors to liquidate the debtor’s fully-encumbered assets in a separate proceeding from unsecured creditors be granted recognition in the United States? In In re ABC Learning Centres Ltd., No. 12-2808 (3rd Cir. Aug. 27, 2013), the United States […]

Should a foreign restructuring process that allows secured creditors to liquidate the debtor’s fully-encumbered assets in a separate proceeding from unsecured creditors be granted recognition in the United States? In In reABC Learning Centres Ltd., No. 12-2808 (3rd Cir. Aug. 27, 2013), the United States Court of Appeals for the Third Circuit determined whether an Australian insolvency proceeding should be accorded recognition under chapter 15 of the Bankruptcy Code and whether the debtor’s fully-encumbered property in the United States was protected by the automatic stay.

Background

ABC Learning Centres Ltd. was an Australian corporation providing child care and educational services around the world. ABC conducted business in the United States primarily through subsidiaries, including ABC Developmental Learning Centres (USA) Inc. RCS Capital Development, LLC contracted with ABC Developmental to build child care facilities in the United States. Litigation between the parties ensued, and RCS won a $47 million verdict against ABC Developmental in Arizona state court. RCS, separately, was a defendant in an action brought by ABC Learning against it in Nevada.

In November 2008, ABC Learning’s directors entered into Voluntary Administration under Australian law to examine reorganization options, which breached ABC Learning’s loan agreements with its secured creditors and triggered the creditors’ rights to realize their assets through a receivership process under the Australian Corporations Act. The secured creditors exercised their rights and appointed a receiver. All of ABC’s assets were encumbered by the liens of the secured creditors.

In June 2010, ABC’s directors voted to commence liquidation proceedings. Under Australian law, the receivership continued during the liquidation. The liquidators, as foreign representatives, petitioned the United States Bankruptcy Court for the District of Delaware for recognition of the insolvency proceedings. The petition for recognition was filed prior to entry of a final judgment in the Arizona matter, and the immediate focus of the stay was ABC’s suit against RCS in Nevada. The bankruptcy court found that the Australian liquidation was a foreign main proceeding which met the requirements for recognition under chapter 15 and did not manifestly contravene public policy. The bankruptcy court also stayed all actions against ABC and ABC’s property in the United States and granted RCS’s motion to lift the automatic stay for the sole purpose of converting the Arizona verdict to a final judgment and applying the judgment against the Nevada action. On appeal, the United States District Court for the District of Delaware upheld the bankruptcy court’s orders. Nevertheless, RCS appealed to the Third Circuit because RCS wanted relief from the stay to enforce its judgment against ABC.

Liquidation and Receivership Proceedings Under Australian Law

Under Australian law, a company’s directors may determine whether the company is insolvent and initiate liquidation proceeds. Once a liquidation has commenced, unsecured creditors are prevented from initiating or continuing legal proceedings. Secured creditors participate in separate receivership proceedings in which a receiver realizes secured assets and distributes the proceeds. The receiver only represents the interests of the secured creditors.

Receiverships can proceed in parallel with liquidations, and secured creditors may elect to surrender the secured assets to the liquidator and receive a distribution through the liquidation. Whereas a receiver represents only the secured creditors, a liquidator represents all creditors. The receiver does not operate independently. It has authority to review the appointment of the receiver, and investigate and challenge the liens asserted by secured creditors.

Was the Australian Insolvency Proceeding Entitled to Recognition?

Section 1517 of the Bankruptcy Code provides that “an order recognizing a foreign proceeding shall be entered if . . . such foreign proceeding for which recognition is sought is a foreign main proceeding” and the petition meets the administrative requirements of section 1515 of the Bankruptcy Code. Section 101(23) of the Bankruptcy Code defines the term “foreign proceeding” as a collective judicial or administrative proceeding in a foreign country under an insolvency law.

Even though RCS recognized the liquidation was a foreign main proceeding, RCS contended that only the receivership, a non-collective proceeding, benefitted from recognition. Effectively only the receivership was recognized, and recognition was granted in error. In dismissing RCS’s argument, the Third Circuit noted that the fact that ABC’s assets were entirely leveraged did not determine whether the Australian proceedings were collective, and that chapter 15 does not forbid recognition where a debtor’s assets are fully encumbered.

RCS further argued that because the receivership was a non-collective proceeding, recognition would contravene the public policy in favor of collective insolvency proceedings. The collective proceeding requirement reflects United States policy “to provide an orderly liquidation procedure under which all creditors are treated equally.” The Third Circuit found that it was “undisputed” that the Australian liquidation was a collective proceeding because the liquidator was required to distribute assets on a pro rata basis to creditors of the same priority, and secured creditors were entitled to recover the full value of their debts by realizing the value of the assets securing those debts and submitting an accounting to the liquidator. In fact, the Third Circuit found that recognition would advance the collective proceeding policy, because RCS had sought to attach assets before the secured creditors could realize them.

Are ABC’s Assets Protected by the Automatic Stay?

Section 1520 of the Bankruptcy Code provides that, upon recognition of a foreign main proceeding, the automatic stay under section 362 of the Bankruptcy Code applies with respect to the debtor and the debtor’s property within the United States.

RCS argued that the secured creditors effectively owned ABC’s property because all of ABC’s assets were encumbered and because the receiver had the right to use and dispose of the property at its discretion. According to RCS, ABC held only bare legal title to those assets rather than an equitable interest, and therefore, pursuant to section 541(d) of the Bankruptcy Code, ABC’s estate would also hold only bare legal title to the assets, and those assets should not be considered property of the estate.

The Third Circuit disagreed, finding that ABC retained an equitable interest in the property because (i) the receiver must turn over any realized funds in excess of the value of the liens, (ii) ABC retained the right to redeem the encumbered property, and (iii) the liquidator had the right to challenge the liens. According to the Third Circuit, because ABC retained an equitable interest in its property, the property was property of the debtor and was protected by the automatic stay.

In so finding, the Third Circuit noted that chapter 15 does not create a separate bankruptcy estate and that in general, section 541 of the Bankruptcy Code is not applicable in chapter 15 cases. Even if the court applied section 541(d), however, which provides that if the debtor holds only bare legal title in particular assets, the estate will also hold only bare legal title, the property in the United States would still be property of the estate, because ABC has an equitable interest in those assets. Because the United States property was property of ABC’s estate, RCS was stayed from enforcing its judgment.

RCS had argued that ABC’s Australian insolvency proceedings should not be recognized in the United States because the estate was not being administered for the benefit of all creditors. While the Third Circuit found that the Australian insolvency proceedings were entitled to recognition, despite the fact that secured creditors were allowed to participate in a process separate from unsecured creditors, the Third Circuit’s decision was based, at least in part, on the fact that Australian law provided for a priority scheme, albeit a different priority scheme from the Bankruptcy Code. Whether the Third Circuit would have reached the same conclusion if the foreign representatives had only sought recognition for the receivership proceeding is an interesting question perhaps left for another case and, another day.